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US elections: Polarising politics, heightened uncertainty

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  • US elections: Polarising politics, heightened uncertainty

Some believe the US presidential election could serve as a catalyst that unites Washington into taking decisive action in one direction or another. Don't hold your breath, says David Mazza.

As Americans head to the polls, there are some parallels to the 1980 presidential election as Republican candidate Mitt Romney looked to cast darker shadows around a president plagued by a fledgling economy and high unemployment. On the heels of one of the most challenging economic periods American investors have ever known, the US economy has made some progress over the last four years. However, questions about the robustness of the recovery linger. While markets have been performing well as of late in 2012, they remain haunted by the spectre of extreme performance volatility, which has recently given way to an environment characterised by extreme uncertainty of future direction. So what could victory by either presidential candidate mean?

What happens if Romney wins?
In Romney's Day One, Job One plan, he notes that, should he emerge victorious in November, he would immediately take action. He'd start by introducing bills to reduce the corporate income tax rate to 25%. He'd also facilitate the negotiation of new trade agreements, invigorate options for domestic energy solutions, move retraining programmes to the states and cut non-security discretionary spending by 5%. In addition, his executive orders would ensure that each state was essentially given the authority to end Obamacare. Additional orders would serve to remove Obama-era regulations, rapidly issue permits for drilling in pre-approved areas, ask the Treasury to label China as a currency manipulator and move to be more pro-business at the expense of organised labour.

In addition, Romney's past comments on the Fed hint of his views on the role and moves of the Federal Reserve. Romney recently remarked: "A QE3 would do the same thing [as QE2], but the potential threat down the road is inflation, and that's something we have to be aware of, and the last QE2, the last monetary stimulus, did not put Americans back to work, did not raise our home values, did not bring jobs back to this country or encourage small businesses to open their doors."

In general, should Romney take the White House, some of the uncertainty that has been permeating of late would be reduced. However, much of this will depend on the fate of his fellow Republicans in the House of Representatives and Senate. Many of Romney's proposals would directly benefit dividend-paying investments due to favourable tax treatment and may encourage more companies to initiate or raise dividend payments.

Therefore, in addition to stocks generating a high yield, stocks that generate strong, sustainable cash flow could be next in line for a boost. Based on his plans for domestic energy production, the energy sector and many sub-sectors would benefit. An improved regulatory environment could also boost industries that have recently taken heat, such as chemicals, for-profit education and transportation. Lastly, while not as pro national defence as other Republican administrations, Romney would likely be favourable to aerospace and defence.

What happens if Obama wins?
With an Obama victory in 2013, it will be difficult for a big deficit reduction to occur because the Republican-controlled House has no appetite for tax hikes without spending cuts. Any reduction that does move forward will be modest at best. Based on the present situation, Obama won't do much until the financial markets potentially impel him to act. At present, the bond market is indifferent, unlike the situation in the mid-1990s, when bond investors protested potential inflationary policies with a sell-off that drove government borrowing costs higher.

Even so, should President Obama be re-elected, it would most likely be the case that taxes will increase for at least a portion of the population. While there has been some debate on reducing the benefits of municipal bonds, there doesn't appear to be a credible assault in place. Doing away with this type of tax break will be hard to stomach, thus they may be left untouched.

Investors should probably be most concerned about the dividend tax changes. If the Bush era tax cuts aren't extended, dividends, for those in the highest tax bracket, will revert to the ordinary income rate of 39.6%. In addition, because of the healthcare bill, capital gain taxes are already going up by 3.8%. At the end of the day, dividends most likely will not be raised to ordinary income, but the possibility that taxes on dividends could increase has left investors cautious. In fact, clarity may not exist until the end of the first quarter.

Thus, under the President's second term, taxable investors may find comfort in municipal bonds due to their still favourable tax treatment. Should tax changes be implemented, REITs could become more attractive relative to other income-producing assets. In addition, the President seems committed to boosting the nation's infrastructure investment, thus stocks in that industry may stand to benefit.

Of course, all investors may seek to exploit the impact of Obamacare on most of the healthcare sector, especially those companies with the most direct exposure to Medicaid. While clean energy remains a priority, the efforts surrounding solar energy will most likely be tempered in the wake of the issues with Solyndra.

Conclusion
In some respects, the election may serve as a catalyst that unites Washington into taking decisive action in either direction. More likely, the election will be so close that both camps become further ingrained into their positions. In this environment, investors may be best served to stay focused on the long term while identifying shorter-term opportunities where they arise.

David Mazza is head of ETF investment strategy for the Americas at State Street Global Advisers' SPDR ETF Strategy & Consulting

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