The past year has seemed remarkably eventful, from trade war, to Brexit, to impeachment, to global protests. Through it all, equities maintained a blistering pace, reversing their 2018 swoon on the back of central bank easing and weakened-but-still-positive global growth. Late in 2019, certain developments seemed to augur a more stable narrative, including approval of a revised U.S.-Canada-Mexico trade agreement, a seeming truce in the U.S.-China trade war, and a decisive election victory for Boris Johnson’s Conservatives, setting the stage for a more orderly Brexit.
Still, many key issues have yet to be resolved. And built into the calendar is one of the most consequential U.S. elections in recent memory—with wide-ranging potential outcomes implying quite different landscapes for the economy and markets. At the outset of 2020, Neuberger Berman’s Asset Allocation Committee is relatively optimistic on risk assets, in light of positive fundamental trends and easing of the hazards noted above. That said, political risk will likely be a key part of the 2020 landscape, as suggested in our firm’s recent Solving for 2020 outlook. Starting with the U.S. election, we lay out some of the issues and events to watch as the year progresses.
A Bitter U.S. Contest
Donald Trump has dominated the political landscape for three years, with an aggressive, provocative style that has been both vilified by critics and celebrated by supporters. A populist on immigration, foreign policy and trade, he has acted like a traditional Republican on taxes, regulation and judicial appointments. Trump has low approval ratings but a devoted political base that includes a large segment of the “forgotten” working class that helped put him over the top in 2016. The impeachment process appears to have had little impact on his political support.
On the other side, the large Democratic field of candidates is skewed toward the party’s progressive wing. Former Vice President Joe Biden is the establishment moderate, with Bernie Sanders and Elizabeth Warren challenging him from the left, and Pete Buttigieg and Amy Klobuchar looking for room in the center. Former New York City Mayor Michael Bloomberg is a late, well-funded entrant. Multiple other candidates with (thus far) minimal impact round out the field.
Despite a seemingly endless media windup, the primary process has really just begun. Writ large, Democrats seem to value “electability” more than any other quality this time out, but what that actually means is the subject of debate. Biden’s age, questions over Ukraine and his uneven public appearances have undermined his frontrunner status; however, the potential cost of the Green New Deal, Medicaid for All and free college tuition proposals has hampered the progressives. Labour’s drubbing in the U.K. election is cautioning Democrats to avoid moving too far left and alienating centrist, general-election voters.
Regardless of who becomes the Democratic nominee, defeating an incumbent president may be daunting, and historically has been even more challenging during good economic times (see display).
Advantage to the Incumbent
U.S. Presidential Elections, 1860 – 2016
Source: BCA Research. Reelection rate is based on the popular vote and refers to sitting presidents running for a second term.
*As a percent of periods that experienced a major scandal.
**As a percent of total incumbent party wins.
At this point it looks like the economic climate will remain positive, aided by the Fed’s last three rate cuts and a healthy consumer. Our Global Fixed Income team currently anticipates U.S. GDP growth of at least 1.5% this year, with some slowing in the first half followed by acceleration in the second. Unemployment should remain low and inflation measured.
Still, it appears that President Trump has little room for error, relying on his solid base and drawing fence-sitting voters in swing states. Unfortunately for him, the trade war has been painful for farmers and workers in the industrial heartland who helped drive his victory in 2016.
The Midwest Has Suffered in the Trade War
Source: BCA Research, Institute for Supply Management, Federal Deposit Insurance Corporation. Data through October 2019.
*Shown advanced by six months.
In theory, greater clarity as to outcomes should emerge as we move through the primary season, summer conventions and run-up to the general election. Even then, however, the race could be tight, and, keeping in mind 2016’s surprise result, it may be very hard to predict who the ultimate winner is. The picture becomes more fluid if one takes into account the Senate, where the Republicans’ 53 – 45 majority is now considered more vulnerable. With split-ticket voting becoming rarer, the party that takes the presidency could take the Senate, which for the Democrats could translate into control of two of the three branches of government.1
Broad Implications, an Uncertain Outcome
Presidential contests always have broad implications for the economy and investors, but in this instance the stakes appear particularly high. At the extremes, an unwinding of the 2017 tax cuts would take a chunk out of corporate earnings and potentially limit managements’ ability to commit capital to drive growth. A government takeover of the health care system would have monumental impacts on health care-related companies. And more aggressive government oversight could dampen business activity generally. On the other hand, a return to less adversarial trade and governmental relationships could foster more stability, encourage business investment and lead to more meaningful fiscal stimulus, including sorely needed infrastructure repair.
As it stands, the wide policy differences at play, combined with uncertainty around the result, are likely to keep corporate spending in check, at least until there are fewer candidates to assess. This in turn could dampen equity returns as investors wait for signs of improving growth and earnings. Looking again at historical results, stocks have typically seen relatively muted performance in advance of close presidential elections. However, markets have often surged in the weeks that followed—generally regardless of which side actually won (see display).
S&P 500 Has Often Surged in Weeks After Close Election
Source: Deutsche Bank, Gallup, Haver, DB Asset Allocation. Presidential elections when poll gap was less than 3 percentage points (1952, 1960, 1968, 1976, 2004, 2012 and 2016); excludes 2000 election, as the election result was contested.
Widening our lens to the full presidential cycle, stock performance in an election year has generally trailed that of the previous year—often by a sizable margin—but outpaced the remaining two years (see display). Given the impressive equity returns of 2019, it’s not hard to imagine a similar pattern this time. Meanwhile, the potential impact of impeachment is unclear. Stock performance was terrible in 1974, but probably due in large part to broad economic weakness rather than solely to Richard Nixon’s forced resignation. In contrast, returns surged in 1998 amid a technology boom, overlooking Bill Clinton’s impeachment and acquittal.
The Election Cycle and Equity Returns
Average S&P 500 Total Returns by Year, 1928 – 2017
Source: Standard & Poor’s, BofA Merrill Lynch. Excluding 2008, the average for presidential election years is 12.9% (still the second highest). Total return data available since 1936; price return data from 1928 – 1935.
Global Political Risks
Beyond the U.S. election, we see a range of variables with political dimensions appearing over the course of 2020. Reflecting broader changes in the global landscape, they are to some degree interrelated—which in the right circumstances could deepen their impact. Here a few key issues, among many, to keep an eye on:
Trade Conflict. In December 2019, the U.S. and China announced that they had reached a “phase-one” deal, in which the U.S. shelved additional tariffs on Chinese products, and China agreed to buy more U.S. agricultural commodities and make progress on intellectual property rights. However, market reaction was muted as many issues remain unresolved, including market access, industrial subsidies, forced technology transfer and sanctions against Huawei, the Chinese technology giant. Much of this is strategic, not just economic, as the U.S. worries about Chinese hegemony. A clear danger is that political/human rights issues bleed into the trade dispute, from Chinese treatment of its Uighur Muslim minority, to the Hong Kong resistance, to U.S. support for Taiwan.
Although the U.S. and China are at the center of trade worries, other flashpoints exist across the globe. While the U.S. allowed a deadline to expire for proposed levies on European cars, it’s possible that the issue could be revisited in 2020, particularly after the general election when Trump (whether victorious or not) will be less worried about optics. The administration may act on an opportunistic basis, as happened when Trump placed new tariffs on Brazilian and Argentine goods in light of their weakened currencies. That said, the president, if antagonistic toward multilateral institutions, has remained committed to bilateral agreements, attaining a far-reaching trade pact with Japan and working with Democrats to finalize an accord with Mexico and Canada.
Brexit Transition. A December 2019 national election appeared to settle the question of whether the U.K. would withdraw from the EU and abide by the 2016 popular vote on Brexit. Boris Johnson’s Conservatives won a decisive 80-seat majority in the House of Commons as voters sought an end to paralysis, but were wary of the left-leaning agenda of Jeremy Corbyn’s Labour Party. Assuming likely Parliamentary approval of his deal with the EU and formal departure by January 31, Johnson will have all of 2020 (and possibly longer) to iron out withdrawal details. Although separation is generally expected to dampen U.K. growth potential, greater certainty may contribute to business investment. However, much depends on the nature of the relationship that Johnson is able to develop with the EU and whether the U.K.’s new independent status can foster healthy individual deals with the U.S. and others.
Popular Unrest. Back in Victorian times, there were reports of “spontaneous human combustion,” where individuals were said to explode without warning. Although eventually chalked up to folklore or more plausible explanations (smoking in bed), the metaphor may be apt to describe intense protests that, aided by social media, have erupted periodically in multiple regions. Latin America provides some recent examples, with triggers ranging from alleged election fraud (Bolivia), pension and tax reforms (Colombia), the suspension of fuel subsidies (Ecuador) and an increase in metro fares (Chile). In Hong Kong, protests showed the effectiveness of determined activists in the face of a powerful government. The unrest has often reflected deeper grievances—in Latin America, long-term economic weakness and/or disconnected political leadership, and in Hong Kong, fears of the erosion of political rights. However, in some cases the reaction of governments has been constructive, and more broadly we don’t see recent events as the source of new contagion. Rather, they represent ongoing uncertainty fostered by technology that now may be built into the social system.
Mideast Tensions. The long-simmering conflict between the U.S. and Iran has recently accelerated, with the tightening of U.S. sanctions, and retaliatory actions including the storming of the U.S. embassy in Iraq and airstrike killing an Iranian general. At this stage, the implications and direction of the conflict are unclear, given general instability of the region. However, aside from heightening market and oil price volatility, for the moment it appears that any direct economic impact may end up being modest.
Taking Political Risk Into Account
Often, political events and markets operate in parallel worlds. Investors expect a certain degree of political turbulence and, although it may drive additional short-term volatility, markets have historically moved in the longer term based on where fundamentals go. There are times, however, where politics can have a more meaningful impact on markets, precisely because they may have influence on fundamentals or because they reflect issues that investors may have previously glossed over. Hong Kong protests damaged its economy, and thereby its markets; Chile, once a bastion of stability, saw its currency drop 20% as class divides emerged. Overall, markets dislike uncertainty, and if there’s more of it, that can have a dampening impact (see display).
Uncertainty and Valuations
Uncertainty Index vs. S&P 500 Earnings Yield/10-Year Treasury Yield
Higher uncertainty has historically (but not always) been associated with lower valuations, as reflected in a higher earnings-yield premium over Treasuries.
Source: Bloomberg. Earnings yield is earnings per share divided by price.
For the U.S., the presidential contest represents deep-seated differences about the direction of the country, but also a shift in alignment, as Republicans have become more populist on trade, spending and values, and Democrats have focused more on Coastal progressive priorities. The election could have a major influence on the role and emphasis of government, but how that will play out is wildly unpredictable.
Moreover, it’s crucial to mention that the 2020 election will take place, not in a vacuum, but in the context of various macro influences, including a seeming pause in monetary easing, the struggles of China to manage an orderly slowdown, and in Europe a seeming shift in momentum toward needed fiscal stimulus. In terms of trade, developments in 2020 could prove more constructive than 2019, but that doesn’t mean that “globalism has returned.” Like a New Year’s champagne cork, it seems unlikely that the nationalist impulses behind the trade war and Brexit are going back into the bottle.
To conclude, politics are among many of the factors that should be taken into account in making a range of decisions, from asset allocation, to strategy approaches, to sector weightings, to security selection. The effects of a given issue may be broad or narrow; they may be fleeting or lasting; and they may be obvious or indirect. It is crucial to assess their importance from a fundamental perspective and set an investment course that navigates the fine line between risk and reward.