Does politics matter for investors?
Generally speaking, says Max King, markets don’t seem to care much about politics. But every now and again, politics really does matter quite a lot.
“Don’t waste your time analysing the US election” wrote Louis Gave of research group Gavekal a month ago.
Though there were profound differences in style and substance between Donald Trump and Joe Biden, just as there had been between Barack Obama and Trump, he argued, “financial markets do not seem to agree.”
The S&P 500 had delivered a similar return during the Obama years – 12.4% annualised – as during the Trump years – 13.9%. Long-dated bond returns had been better under Trump (9.8% annualized) than under Obama (6.8%), but this was balanced by higher dollar cash returns for European investors under Obama than under Trump.
Moreover, the sector breakdown of performance had confounded expectations. “Big tech was widely seen as hostile to Trump but had done well while real estate had done worse under a property developer than under Obama.”
Trump was seen as benefiting the energy, industrial and financial sectors due to deregulation and his “make America great again” promise – but their relative performances did not improve.
Why should it be any different if Biden succeeds Trump?
Markets don’t seem to care much about politics
US strategist Ed Yardeni points out that after the first presidential debate, the consensus view moved to a conviction that Trump would lose the election. Yet the S&P 500 rallied 6% in the subsequent fortnight.
Meanwhile, last December’s election in the UK has probably buried the threat of a hard-left government for at least a generation. But the UK market has not only fallen in nominal terms but has continued to underperform global markets.
Conservative prime minister John Major’s surprise election victory in 1992 boosted the equity market for a few days – but the rally soon reversed. Since then, elections have made little difference though, arguably, the result was always expected and discounted.
This seems surprising. After all, different parties in both the UK and US have different policies with different economic impacts, particularly on listed equities. For example, Biden has pledged to raise $3 trillion more of taxes. He will increase the rate of corporation tax from 21% (Trump has reduced it from 35%) back to 28%, and plans to deter tax-avoidance through a minimum levy and a doubling (to 21%) in the rate charged on the foreign-sourced income of multi-nationals.
In addition, he proposes to raise the top rate of income tax to 39.6%, limit deductions, raise capital gains tax on those earning more than $1m to their marginal income tax rate, introduce new payroll taxes on those earning over $400,000 a year, and halve estate tax exemptions.
To do all this, Biden will need the Democrats to take control of the Senate. This looks increasingly likely, which would give him a two-year window of opportunity before the Republicans regain control of Congress and gridlock returns, a state of affairs Yardeni regards as ideal for the economy and markets.
Till then, surely Biden’s tax proposals are bad for the market? Investment bank giant Goldman Sachs argues that a Biden win would be bullish for markets as “a large increase in fiscal spending would boost economic growth and help offset the earnings headwind from higher taxes”. But Goldman Sachs, like the Vicar of Bray, will always curry favour with the winning side. Others think tax revenue will fall short of expectations and economic growth will be reduced.
As Yardeni says, "imposing a $3 trillion tax hike during a wobbly economic recovery seems like a very bad idea, but it depends on how the tax revenues are spent. The spending programmes proposed in the Biden Plan will certainly pump lots of money back into the economy, yet another round of massive government intervention is bound to weigh on the long-term vitality and productivity of our economy.”
This is a bigger concern than the tax increases; after all, the correlation between changes in tax rates and revenue received is, at best, weak and often inverse. Corporate taxes paid will not necessarily increase and, as regards taxes on the rich, heiress Leona Helmsley once quipped “only the little people pay taxes.” Harsh, but as Trump’s own tax affairs show, often true.
Either Biden will have to retreat on his spending plans or raise taxes more generally, both of which would help the Republicans regain control of Congress in 2022.
Would a Biden victory embolden the world’s despots?
Before investors relax however, they should take a broader view. Despite Trump’s belligerence, threats and abrupt changes of tack, the US has not faced a real international crisis or a war in his period as president, despite a growing number of megalomaniac or paranoid despots around the world.
Perhaps Trump is too unpredictable for leaders in Iran, North Korea, China and Turkey to take on. But they will have no such qualms with nice, rational and predictable Mr Biden. That could make the world a more dangerous place.
As Philip Stephens wrote in the FT: “democracy’s retreat is a favoured narrative of our times. Wherever one looks, self-styled ‘strongman’ leaders are scorning liberal values. The forward march of democracy has become a retreat.”
Where popular uprisings against dictators used to regularly succeed, they are now failing, whether in Venezuela, Belarus or the Middle East. This encourages despots to believe they can stay in power by whatever means they choose, provided they have tough, well-rewarded security forces. It once seemed that technology was a great enabler of political dissent and rebellion but, as China is showing, it can also be effectively used for repression.
From a long-term perspective, little has changed. In almost all democracies, except perhaps Switzerland, politicians have always tried to load the electoral dice in their favour. Wars, repression, dictatorship, division and instability are a staple of international politics. “This world of ours must avoid becoming a community of dreadful fear and hate and be, instead, a proud confederation of mutual trust and respect” is not a Biden campaign quote, but was said by Dwight Eisenhower, US President in the 1950s. The problem is that for 30 years, we believed the world could be different but, in recent years, the progress has gone into reverse.
Dictatorship is not compatible with rising long-term investment returns
Why does this matter for investors? With political freedom comes economic freedom. And that, according to the Fraser Institute, peaked in 2018.
“Freer economies,” they say, “tend to be richer, grow faster, be more equal and have longer life expectancies” while globalisation helped spread prosperity and democratic practice around the world.
The policy response to Covid-19 has put more of the global economy into the hands of the government, says the IEA (Institute of Economic Affairs), and looks likely to further erode freedom. Noel Coward’s song “there are bad times just around the corner” containing the line “we can’t save democracy and we don’t much care” no longer seems funny but prescient.
In a democracy, the duty of government is to uphold “life, liberty and the pursuit of happiness,” according to the US constitution, for which prosperity is a key condition. Governments that fail or stumble are replaced by the electorate with oppositions that promise to do better.
As Lord Acton observed, “power tends to corrupt; absolute power corrupts absolutely.” Democracies, led by the US, usually limit their political leader to two terms and the experience of those that don’t show why; Vladimir Putin was a good president of Russia for his first two terms but is now a de-facto dictator.
Dictators are not concerned with delivering prosperity, liberty, happiness or even life because they have nothing to fear from the electorate. Their motivation is personal wealth, the exercise of power at home and abroad (hence wars) and the tolerance of widespread corruption to benefit those that prop up their regime.
China appears to be an exception as a repressive regime co-existing with rising prosperity, but Xi Jinping has only been President for seven years and his strategy of repression at home, aggression overseas is becoming steadily more apparent. No other country has succeeded in (or even tried) combining dictatorship with prosperity and Xi’s long-term success with China is far from assured.
Unfortunately, the West has always regarded Russia as a greater threat but is now changing its mind. On that, Trump and Biden agree.
Politics doesn’t matter – until the day the barbarians kick down the gates
As Louis Gave writes, investors spend far too much time worrying about politics, time they should spend analysing companies and economic trends. At this US election, it’s no different; this is not, as many Americans claim, “the most important election of our lifetime.”
But investors need to be aware that markets are not good at foreseeing political developments that are truly dangerous. By examining financial markets, Professor Niall Ferguson has shown that the outbreak of war in 1914 was a total shock, precipitating what would have been the greatest crash of all times if markets had not been closed, some never to reopen.
Contrary to received wisdom about the remorseless and irreversible slide to war over many years, only when Austria delivered its ultimatum to Serbia in late July 1914, did investors and the public in general start to worry.
1,500 years earlier, as Georgina Masson writes in the Companion guide to Rome, “perhaps it was the belief that Rome was eternal - whatever happened in the world outside, Rome would continue – that persuaded the money changers to carry on business as usual on that fateful 23 August AD410 with a Gothic army at the gates.
“Relics of their misplaced optimism can still be seen in the green stains which mark the Basilica Aemilia’s marble pavement, for they are copper coins fused into the stone by the heat of the fire when the Goths, who entered the City during the night, sacked Rome.”
Very occasionally, politics matters a lot.