Schroders’ Joanna Shatney considers effect of US election on markets

Joanna Shatney, head of US Large Cap Equities at Schroders, discusses the impact on the US market if current president Barack Obama wins or loses the pending election.

If Obama wins…

The polls are saying that Obama (pictured) has a slight advantage and whilst this has ebbed and flowed a bit he has consistently had the upper hand. I am working with the base case that Obama retains his Presidential seat.

However, I think the bigger issue is going to be control of the Senate, which is a topic of much debate. While the outcome will be important because the House is already controlled by Republicans, neither party is likely to win by a majority and have complete control. The risk here is that we come out of the election process with as much political gridlock as we had going into it. The consensus view for investors, and we are very much in line with this view, is that the fiscal cliff gets dealt with by pushing it out 12 months. We think the reason this is the consensus view, is that there is so much political gridlock that there is just not enough time to fix it by year end.

The ultimate plan for fiscal reform could take many shapes depending on the outcome of which party controls Congress – so this is not just about who lives in the White House for the next four years.

There are three areas for investors to think about with regards to the 2013 GDP drag from government spending :

One: expiration of the Bush tax cuts, two: sequestration cuts which will impact healthcare and defense budgets, and three: increased Medicare taxes that come with the implementation of Healthcare reform. The last, Healthcare reform, is going to happen as of 1st January 2013, unless Romney wins. If you combine the impact from all of these areas you could get a 3 to 5% drag on GDP. Our view as investors in the US is that we get between a 1-2 percentage point drag from government spending in 2013 from the decision to push off the Federal fiscal reform. While obviously, that is a negative for economic growth rates, we think it is manageable, especially given that state budget cuts have already impacted 2012 by a similar magnitude -meaning that the incremental drag is not that large.

Of course, there is a risk that Congress does not push off the decision and allows for the entire drag to hit the economy, but we put that risk below 20%.

In summary there is a view that the market will sell off significantly if Obama wins but we do not agree with this. We are more inclined to believe that getting the election out of the way is a positive for the market, regardless of the ultimate winner.

In addition, a Republican sweep of Congress and the Presidential race means greater change is likely, which we think will create greater ambiguity for investors to deal with in 2013, driving up equity market risk premium.

If Obama loses…

If Obama loses we hope that we will get some clarity around tax reform but think that this will take time and do not believe a decision will be made on this until the second half of next year.

There will also be a great deal of ambiguity for healthcare as Romney has stated he will repeal the healthcare legislation.

In the case that Obama loses the election the market might experience a short-lived rally, but we think that it would stall until we see some resolution around fiscal reform. Ultimately, we are believers that fiscal reform will get dealt with and continue to look to the positive economic profile of US corporates to drive positive equity returns for 2013, making the election changes another datapoint for investors to digest as we wait for real fiscal reform – probably a long-term story that needs to play out.


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