The race to win the November US presidential election may go down in modern American history as the most unconventional. The nominees of the two major parties both elicit high negative reactions from voters. Moreover, the outcome is far from certain given that, as we saw with Brexit polling, people can be reluctant to share voting decisions that may be viewed as controversial.
Yet one poll result that is not controversial is the clear response of institutional investors in our most recent 2016 RiskMonitor survey: Globally, they view event risk as one of the biggest threats to their portfolios, with 75% of respondents saying it was a moderate or considerable threat. That's up from 53% in 2015 - the biggest jump of any single risk named in our survey.
With such a major risk event on the horizon in the US presidential election, investors need to be prepared for the possibility that either major candidate will win; as such, it is important to understand the candidates' platforms and how they can affect the markets.
Candidate Hillary Clinton's proposed platform calls for higher fiscal spending across a broad range of categories-and higher taxation, although the taxation would be concentrated among the wealthiest Americans. In total, the National Taxpayers Union Foundation (NTUF) projects that Clinton's proposals would result in net increased spending of $160 billion per year.
Clinton's proposed increased government spending could provide a boost to US economic growth, which would be paid for with higher income taxes. Although the wealthy are more likely to save at least some of their income, an increase in taxes on the wealthy will have some negative effect on economic growth (though not nearly as significant as an increase in taxes on lower-income individuals). Clinton's emphasis on higher regulation as well as her more protectionist stance are likely to produce a drag on economic growth.
Candidate Donald Trump also proposes some fiscal spending: infrastructure spending, strengthening border security and tripling the number of immigration officers. However, he would also like to cut a significant amount of current government spending. As a result, the NTUF projects that government spending would actually experience a net decrease of $56 billion per year under Trump's proposals.
Much of Trump's proposed stimulus would actually be derived from a decrease in taxes. Trump proposes fewer income tax brackets and lower income taxes in general; he also proposes significant corporate tax reform. In total, the Tax Foundation estimates that Trump's tax proposals, taken at face value, would result in the US government losing a significant amount of revenue-$10 trillion over 10 years.
The tax cuts Trump proposes are estimated to significantly outpace the savings that would be derived from decreased government spending. However, these tax cuts are likely to stimulate economic growth, even though Trump's economic policies may, according to some analyses, result in larger government deficits and more debt.
Why spending matters
Significant fiscal spending should provide a boost to the US economy, particularly since there has been an absence of fiscal stimulus and an overreliance on monetary policy in recent years. But the economic impact of fiscal spending varies by type:
- Transfer payments, because they typically benefit lower-income Americans, are usually used for consumption rather than saving, and are therefore typically more impactful.
- Infrastructure spending is often considered the most effective form of fiscal policy in terms of its impact on the economy, but not all infrastructure spending has had a substantial impact.
Why tax cuts matter
Tax cuts are one area of fiscal policy that have varying degrees of impact. That's because, like monetary policy, tax cuts indirectly affect economies and employment because they are dependent upon market-participant psychology; people may or may not spend the tax savings they receive. In addition, the efficacy of tax cuts depends on who receives them. Typically, when lower-income individuals receive tax cuts, there is a greater likelihood the money will be spent rather than saved.
Volatility up ahead
While no one knows who will win this upcoming election, nor what their proposed policies will ultimately be, it is important to note that the next president will need support from the US Congress to implement his or her policies. As a result, many of the next president's proposals are unlikely to come to fruition - except for those with broad appeal, such as infrastructure spending.
It is also worth noting that this commentary is not intended to be an endorsement or indictment of any of the presidential candidates; rather, like many investors, we are interested in the stock market's reaction to ongoing developments. And with so much uncertainty, one common theme has emerged: This is an "all-bets-are-off" election, so investors need to be prepared to be surprised - which means to be prepared for more volatility.
In fact, political developments around the globe could be the biggest source of volatility for investors this year. In this environment, investors will need to be very discerning about the risks they take. That means focusing less on passive index investments and more on actively managed strategies. In addition, investors may be better served by being tactical in their asset allocations and sector allocations, and by focusing on downside protection in their portfolios.