AS THE US presidential elections close in, investors are looking ahead to what the outcome will mean for the various issues that the country’s economy faces. Perhaps the most important of this is the so-called fiscal cliff. Under the Budget Control Act of 2011 – signed to deal with the country’s large deficit – the end of this year will see taxes automatically go up a little. Meanwhile, budget cuts previously agreed upon will go into effect. That’s unless the Democrats and Republicans in Congress can agree on a new deal.
In an Oct 31 report, Citigroup calculates that the fiscal cliff represents an “unprecedented” US$800 billion ($977 billion) shock – about 5% of GDP. “We estimate that GDP would decline by 1% with unemployment persisting above 9.5% amid weakened financial conditions and the lack of an effective monetary policy buffer.”
If, however, both sides are able to hammer out a “grand bargain”, the jobless rate could fall to near 6%. Such a situation, the bank says, would involve reforms phased in over several years and modest near-term restraint. It would also be modelled on a situation of declining policy uncertainty and rising business confidence, which propels growth into a 3% to 4% range for several quarters.
This grand bargain scenario, however, is very unlikely. Citigroup points out that even the historic budget compromises of the 1980s and 1990s, which were actually used as a base for drawing up the bipartisan Budget Control Act, weren’t so far-reaching. But the outcome of the presidential election will determine, to a large extent, what happens next.
POSSIBLE SCENARIOS
Citigroup’s base case scenario is for President Barack Obama to win a second term. It sees the Republican Party continuing its control of the House of Representatives and the Democratic Party retaining power in the Senate. “Whatever one thinks of the Obama administration, it has a three-year record of cutting fiscal deals with Congress, however piecemeal and short-term. A continuation of the status quo suggests a continuation of the status quo: more late-stage deal-cutting,” the report says. “We expect another piecemeal, short-term fiscal deal that temporarily resolves the fiscal cliff problem.”
If, however, Mitt Romney is elected president, or the Republicans win the Senate, Citigroup isn’t ruling out the possibility of simple blanket extensions on the expiring tax cuts and sequestration budget cuts. “A victory for Romney or Senate Republicans may also mean that the GOP, fresh from victories at the polls and looking to put their own stamp on a fiscal cliff solution, will hold off until January for its own fix.” The new president’s term begins on Jan 20, which is a Sunday.
Besides the uncertainty that the resolution of the fiscal cliff is casting on equity markets, a win for either candidate could also mean different things for different industries. Citigroup believes that a Romney victory would benefit the energy, healthcare, defence, utilities and financials industries. Romney’s campaign promises have included repealing the Dodd-Frank financial bill’s restrictions – which, among other things, seeks to deal with the problem of financial institutions that are too big to fail – and replacing the Affordable Care Act, also known as Obamacare.
“He has also reiterated comments from Defence Secretary Leon Panetta about the dangers of severe defence industry spending cuts coming under the sequestration programmes on top of current budget proposals to trim back military appropriations,” Citigroup adds. “Coal miners and electric power companies most likely would enjoy some environmental related relief.”
Meanwhile, Obama’s re-election would be favourable to alternative energy, generic pharmaceuticals, technology and entertainment. These are sectors that the Obama administration has previously spoken in favour of. For instance, Obama has appointed a federal chief technology officer. “A tax system favouring capital gains over dividends might encourage more stock buyback activity as well as provide a greater incentive for funding new business start-ups,” Citigroup adds.
The bank notes that buyback activity can be a meaningful contributor to equity market upside opportunity, with the S&P 500 Index being likely to shrink by as much as 3% due to stock buybacks this year. “Companies could choose to reallocate more money towards buy-ins versus dividends if the Bush tax cuts expire and the treatment of dividend income rebounds to ordinary income tax rates (39.6% for upper income Americans) as compared with the lower 20.0% for capital gains.”
VIEW AT HOME
Of course, little of this industry spin-off is likely to trickle down to the Singapore market. But there is one point that investors here may be more interested in. Romney has said that if he wins, he would replace Federal Reserve chairman Ben Bernanke. Bernanke’s term only ends in January 2014, and there’s no certainty that he would want another term anyway.
But under Bernanke, who is known to have extensively studied the economic policies that led to the Great Depression, the US has engaged in three rounds of increasingly creative quantitative easing. Romney has previously expressed views that disagree with these policies.
Without the loose monetary policies of the US, there would certainly be some alleviation of inflationary pressures in the Asian region. But most market watchers think that it could have a negative impact on the liquidity that’s been driving Asian markets. “Mitt Romney’s business friendly policies would seem to be more positive for the share market, but bear in mind that historically US shares have performed better under Democrat Presidents and Romney’s commitment to not reappoint Fed Chairman Bernanke in January 2014 when his term expires is a possible negative,” says Shane Oliver, head of investment strategy and chief economist at AMP Capital.
As elections go, this is probably going to be a defining one.
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