Whichever president the United States chooses in its Nov.6 election, expect the unexpected as it pertains to global markets and the effect it'll have on your investment portfolio.
It could be argued that no nation outside the U.S. will feel any shift in economic policy quite in the way that Canada would. Even former Prime Minister Pierre Trudeau once remarked living next to America is "in some ways like sleeping with an elephant. No matter how friendly and even-tempered is the beast, if I can call it that, one is affected by every twitch and grunt."
Sure, the tax implications don't really apply to Canadians. But whether it's incumbent President Barack Obama or Republican candidate Mitt Romney that the American people hand the keys to the Oval Office to, either of their policies will have dramatic impacts on the global economy.
The market risks are clear. The American economic recovery continues to stagnate and unemployment remains high at approximately 8.3 per cent, as of July. Moreover, equities have dropped nearly six per cent in May and U.S. Treasury yields, which move inversely to prices, are trading just shy of record lows. The yield on 10-year Treasury notes fell to a record 1.38 per cent on July 25.
U.S. market performance during presidential terms
Looking historically at the performance of U.S. markets during the four-year presidential cycle from 1928 through to 2009, Bob Gorman, chief portfolio strategist, TD Waterhouse in Toronto, says what stands out is a stark contrast between the first and last two years of a presidential term.
"Over that roughly 80-year period, the return of years one and two combined, on average, is about eight per cent. The combined return for years three and four is approximately 22 per cent," he says. "The cumulative return in the second half of a term is about 175 per cent higher than the first half, which is an astonishing statistic."
Historically, from a financial perspective, a president's third year is the best, followed by year No. 4. Gorman says these figures have been fairly consistent over the decades but the 2008 financial crisis has thrown a wrench into that data.
"The numbers since the credit crisis have not been consistent with this trend. So if you think about the 2008 presidential election year, it was a miserable year for the market. 2009, the first year of the Obama Administration, a year that is typically quite poor, saw a big bounce back of about 23 per cent," he notes. "The events associated with the credit crisis have greatly distorted what has been over time a fairly consistent pattern. That's important to bear in mind."
Fiscal cliff looming
Considering what will transpire following the coming U.S. federal election, Gorman's view is that the stakes are especially high as we head towards the fourth quarter of 2012.
"This is partly because of what's called the 'lame duck' session of Congress which is the Congressional session that follows the presidential election but before the inauguration of the next president," he explains. "It's very likely we could see a fairly heated debate about the issues surrounding what's known as 'the fiscal cliff'."
Unless Congress acts, across-the-board income tax cuts are set to expire on Dec. 31st, and deep, automatic spending cuts of $1.2 trillion over 10 years are slated to begin on Jan. 2nd.
Debt ceiling battle to heat up again?
The ongoing argument between Democrats and Republicans over the U.S. debt limit is also a simmering factor to watch out for.
"Unless Congress and the President agree on something this year, there will be some very significant spending cuts," Gorman adds. "If nothing happens at all and both events take place (taxes rising and government spending cuts) then estimates are suggesting U.S. GDP will drop by four per cent next year … this implies recession."
Jack Ablin, chief investment officer at BMO Harris Private Bank in Chicago, in many ways, the U.S. election this year is a referendum on the size of the U.S. Government.
"Those that want to see the government take a bigger role in providing for the wellbeing of Americans will likely vote for President Obama," he says. "Another philosophy, which is rooted in decades of political platforms, is the free market philosophy. If we can provide everyone in America with an equal opportunity, and this is more of a Republican approach, then we have winners and losers but everyone had a chance."
Who is more investor friendly? Obama or Romney?
Ablin says whether or not President Obama retains his seat or Republican candidate Romney takes over, it's hard to say what might unfold because the budget is what it is and there's not much wiggle room.
"But I do think there'll be policy decisions that'll shift and one will be taxes, which clearly impacts markets. For example, there's a perception, and it's probably true, that President Obama is not investor-friendly whereas Romney is," he says. "You'd probably see dividend tax rates stay relatively low and capital gains tax rates stay relatively low under a Romney administration. Under an Obama program, it'll probably move higher and that could potentially impact market growth."
He also highlights an ongoing tug-of-war over returns on capital and returns on labour. For the last 40 years, capital has won out over labour, he says but that might change. "Under an Obama program, you could potentially see a shift away from capital and more toward labour which means returns on investments would shrink and we could see inflation move higher and productivity move lower," he says.
It's true to say that incumbent politicians will do everything in their power to stay in office. If that means stimulus spending, interest rate and/or tax policy shifts to make people feel wealthier, they'll do it, Ablin remarks.
"But with the situation in 2008, the only thing we have left is monetary policy and the U.S. Federal Reserve increased its balance sheet from $900 billion to $2 trillion in a matter of three months just to keep the ship from going under water."
Meanwhile, and according to the U.S. Bureau of Economic Analysis, the American economy slowed sharply in the second quarter. Expectations for the U.S. Federal Reserve to step up and deliver a third round of quantitative easing (QE) to help shield the embattled U.S. economy continues. But even another blast of QE won't dissipate the lasting gloom that hangs above the world's largest economy necessarily.
"It's entirely likely (a third round of QE stateside)," he says. "The impact has become more and more dilute as these announcements come through the pipe. Now you've got a Fed balance sheet of nearly $3 trillion … it takes a lot more to really wow people and I don't know how much fire power they have left."
One last point to be mindful of is the debate surrounding TransCanada Corp.'s Keystone XL oil pipeline. In Ablin's view, the BP oil spill left a bad taste in President Obama's mouth.
"He doesn't want to be an energy-friendly president, he doesn't trust it," he adds. "I do think a President Romney would be willing to engage a pipeline. I'd say most Americans would like to see a pipeline relationship between Canada and the United States."