Much has already been written about the potential impact of the 2016 Presidential election results. While opinions vary widely, there is some consensus on what may happen based on recent comments and election campaign promises. In this brief article, we will review some of these expected changes and their impact on various securities markets. Finally, we will offer our views of some of the changes expected and where we see some of the risk and reward opportunities.
One widely expected outcome, regardless of election results, is an extremely large infrastructure bill passing in the early days of the next Congress with significant bi-partisan support. Additionally, we expect some tax reform (lower rates with possibly some tax simplification) in both personal and corporate tax rates. Likely to also occur is a long-awaited tax holiday encouraging corporations to bring back funds held overseas to the United States at a lesser tax rate. Finally, increased military spending is likely to occur in the coming years.
The various spending and tax cuts discussed above will likely lead to a significantly higher national deficit, hopefully offset by stronger economic activity and therefore additional tax revenue – in other words, a classic supply side economic bet. Some forecasters have indicated likely national debt levels approaching $20 trillion in the next 3-4 years. By way of comparison, our current public debt level is around $14 trillion and it was about $7 trillion when President Obama took office in early 2009. The political hope is that additional economic activity and therefore additional tax revenue, will flow into the U.S. Treasury before the deficit gets too high, and this additional revenue will actually begin to reduce our debt in coming years.
Post-election, interest rates have already increased significantly. Currently the bellwether 30 year U.S. Treasury note yields 3.09% compared to 2.60% prior to the election. Even short-term rates as measured by the 2 year U.S. Treasury note rose from a yield of 0.80% before the election to 1.10% currently. We expect inflation to also increase from its current reading of approximately 1.5% to a level closer to 2.5% to 3.0% or higher in coming years. Given our inflation expectations, we would expect interest rates to move higher from current levels over the next few years. However, this is highly contingent upon real GDP moving from its current level of close to 1.5% (YOY) to something close to 3.0% (YOY), or even higher.
While we are optimistic and hopeful that economic activity will pick up over the next few years, we certainly see some significant risk in making this large “supply-side” bet. Our initial concern is that we are cyclically in the late stages of this admittedly weak economic recovery. This recovery is already approaching its ninth year and signs of weakening in autos and other consumer spending trends are beginning to occur. It has been rare that any economic cycle has extended much beyond 10 years without at least a minor economic setback/recession.
The impact of these potentially higher rates is very straightforward as it pertains to bonds; higher rates mean lower bond prices. How much lower depends primarily on the duration of the bond. Less predictable is the impact on the stock market and equity prices. Typically, higher rates are associated with lower price/earnings ratios (competition for investable dollars between stocks and bonds), but if a lower tax rate for corporations and a more robust economy translate into better after tax earnings, stock prices could continue to increase even in the face of lower price/earnings ratios. Already in the post-election market environment, shares of bank stocks, energy names, infrastructure related issues, etc. have performed relatively well versus other stocks. Commodity prices are also likely to move higher based on stronger economic growth and higher levels of inflation. Impact on the U.S. dollar and other currencies is more difficult to predict as there are many conflicting aspects of currency pricing.
Jim Bernard, CFA, is the Managing Director, Fixed Income at Ancora Advisors LLC a SEC Registered Investment Advisor. He is also a Registered Representative and Registered Principal of Safeguard Securities, Inc. (Member, FINRA/SIPC)
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