Election Tea Leaves

A global grass roots political upheaval is spreading. Brazil has ousted its president and Venezuela is an inch away. Brexit was a core “no more” vote against immigration. The U.S. was a surprise double header with Republicans taking both the White House and the Congress. France seems certain to change and even Mrs. Merkel is under attack. A growing faction of the democratic electorate feel disenfranchised and restive with their governments’ policies either making inroads on their everyday lives or leaving them economically disadvantaged. Well intentioned legislation such as health care for the poor or regional trade agreements are viewed as being poorly planned and executed, or damaging to jobs. Government is seen as exercising excessive power and not understanding the consequences. Voters are drawing a line in the sand and ousting those in power or rejecting anointed successors.

Since World War II there have been 18 U.S. presidential elections. Each has had its unique characteristics although often economic conditions or international problems were the controlling determinants. The 2016 election was an outlier as unemployment and inflation were low and we only had an arms’ length involvement in the Middle East. The candidates personalities and backgrounds were the focal points and issues seemed an afterthought. In some respects, there were similarities to the 1980 Jimmy Carter – Ronald Reagan campaign. Carter was pro government while Reagan was anti-government and wanted to reduce taxes. Reagan was a much different personality than Trump but they shared a belief in the Laffer curve (cut taxes and the GDP will grow faster) and the need to build defense. Reagan won by a big margin but interestingly his critics viewed him as a mediocre actor and not fit to be president. The dollar started a sharp long term advance the day he was elected. Tax cuts were enacted in 1981 and the stock market which had been suffering from inflation, high interest rates, and a recession jumped in August 1982 on its way to a multi-year advance.

Rarely has the country elected a President like Trump with strong controversial positions on several key issues. However, it should be remembered politics has long been characterized as “the art of compromise”. The President Elect has a challenge in front of him to deal with a Republican Congress that has many disparate views and priorities. They are generally on the same page regarding corporate tax reduction, changing Obama care, supporting infrastructure spending, bolstering military outlays, revising Dodd-Frank, reducing government regulation, and appointing conservatives to the Supreme Court. Less clear is their willingness and ability to resolve multi-faceted perspectives on immigration, trade, climate, entitlements and personal taxes and picking up some Democratic support along the way.

In the three trading sessions following November 8, the market has already voted for higher interest rates, less bank reform, higher infrastructure spending, more military support, lower corporate taxes, reduced penalties for recouping corporate cash abroad, reducing payments for hospital services and no price controls on drugs. Higher interest costs will certainly hurt the federal budget. Even the advocates for tax cuts acknowledge the deficit will grow in the first few years. The tidal shift from stocks to bonds looks to be over. The S&P 500 effective tax rate is expected to decline from 27% to 20% which would put 2017 earnings at about $133.00 per share if the rate was in place for the year. Early predictions are for the change to occur mid-year. However, the market rarely awards higher valuations for one time tax declines and especially when they are accompanied with higher interest rates. Higher stock index prices clearly rest on better economic growth. New opportunities will be best found in the shifting landscape among sectors and industries.