US presidential election: what financial markets think

2016 has often seemed like a slow, relentless march to a populist and nationalist dystopia in the UK, Europe and the wider world. In two weeks, American voters will have the opportunity to take us off-route, or propel us further along it. The US presidential election is unquestionably the most important global part of the narrative unfolding before us. We weigh these things up in different ways as political and social scientists, economists, historians, business people, or mere citizens. But financial markets also have their own peculiar way of judging the outcome. And what they are saying is both surprising and perplexing. It will be important for the rest of us too because of the secondary impact on, for example, the UK and global equity markets, and currencies.

The raw material comes from a recently published study by Justin Wolfers at the University of Michigan, and Eric Zitzewitz at Dartmouth College. They delved into the bowels of prediction, stock and other markets after the first Clinton-Trump presidential debate on 26th September, and then again after the release of the Access Hollywood video-tape eleven days later, to try and evaluate what financial markets think about the 58th presidential election.

In fact, they also collected data historically to judge the election effects on asset prices more generally. They point out, perhaps unsurprisingly, that the most significant effects are generated by upset victories such as that of Truman v Dewey in 1948, or by resolution of closely fought contests such as Bush v Kerry in 2004. When presidential candidates have had a strong lead, or when presidents have sought second terms and been strong favourites going into the contest, for example, Ronald Reagan, Bill Clinton and George W Bush, there was little or no news for financial markets to respond to or discount.

This time, of course, it is different. For until very recently, the contest has been judged too close to call. And despite Trump’s remarks in the third and final presidential debate, there are still many who think that the vote on the day may be a lot tighter than the polls currently suggest. The comparisons with the Brexit referendum are made frequently, as is well known in the US and here.

So what did the authors find in their event study? Basically, they establish that a Clinton presidency would be good for the S&P 500 index, which would be about 11 per cent better under her than under a Trump presidency. This would be expected to trigger rallies in the FTSE and other global equity markets. They also suggest that stock market volatility would be lower, and that US treasury bond yields and oil prices would be modestly higher. In currency markets, the Mexican peso and Canadian dollar would gain, as would the currencies of other countries with which the US had free trade agreements, including South Korea, Australia and New Zealand.

In other words, they think that financial markets would respond more positively to a Clinton presidency, which is thought more compatible with a relatively healthier domestic and global economy. This seems to me a wholly plausible judgement. Hilary Clinton has proposed a $275 billion infrastructure programme, and wants to use $25 billion to capitalise an infrastructure bank that would in turn lend ten times this amount to fund projects. She also has programmes on tuition fees, child care costs, parental leave and tax credits designed to further social and employment objectives. The other side of this of course is higher taxes on top income earners, businesses, and big banks.

Trump, by contrast, has pledged significant tax cuts, especially for the better off and business, and discretionary spending increases, including on infrastructure and an additional $450 billion on defence. He wants to push economic growth up to 4 per cent—a task most people think of as pie in the sky, except at the risk of overheating the economy and plunging it back into crisis. Either way, bigger deficits are likely, but Trump’s programmes are seen as “wilder” and more destabilising—not to mention his anti-trade and anti-migrant rhetoric which, if translated into actions, would also have significantly negative economic repercussions. In weighing up the protagonists’ published proposals, the independent and non-partisan Committee for a Responsible Federal Budget reckons that by 2026, Trump would have raised Federal debt from 80 to 105 per cent of GDP, whereas under Clinton, the rise would taper off at just under 90 per cent.

The findings of the election and markets study raise some interesting questions and issues.

First, what market folk would call the “Trump discount”—more negative outcomes under Trump–is an anomaly. In almost every presidential election going back to 1880, equity markets rose on news confirming that a Republican candidate would win. So, in this respect, financial markets in 2016 seem to behaving completely differently.

Second, financial markets are pretty focused on key issues, and these don’t normally extend to social welfare or issues of fairness. Rather, they are concerned with the taxation of capital, the climate in which returns to capital do better, and the operating environment for companies. Given that Trump’s policies are unquestionably more friendly towards wealth and capital, it is curious that financial markets express higher levels of comfort with a Clinton presidency.

Third, the popular narrative behind the Trump phenomenon and Trumpism focuses on the negative fallout from globalisation, immigration and liberal elite neglect on wages, manufacturing jobs, communities and so on. If this were really the kernel of the argument, you would think that the uprising of the discontented and alienated would be across the board. And many have believed that for this reason, Trump will prevail. Yet this narrative, while not wholly incorrect, is only a part of a more significant explanation. Some of the white working and middle class may be disaffected, but their black and Latino counterparts aren’t going to be voting for Trump. A majority of working and middle class males may vote Trump, but not women by all accounts. Older working and middle class people may vote Trump, but seemingly not younger ones.

Put another way, the complex interaction of race and religion with economics in American politics has created a fractious and populist climate in which a Trump presidency is seen by financial markets as potentially disruptive and destabilising. And it is this—exceptional for a GOP candidate—that the weathervanes of finance find uncomfortable and threatening. Ronald Reagan made his 1984 re-election campaign about “it’s morning again in America.” In this vein, Trump’s is more “night time” than morning. Clinton may not be able to keep the US out of recession forever and she won’t be spared potentially tough economic and political problems in the next four years, especially if the House and or Senate were to prove obstructive, but financial markets are unquestionably leaning her way.