US Presidential elections inevitably lend themselves to speculation about the potential impact on the US economy and financial markets. Periods of robust or weak economic growth become associated with the leader at the time, regardless of the president`s actual influence.
While the US President is commonly considered the “most powerful person in the world”, it is in fact the decisions of the US Federal Reserve’s (Fed) president that have a more meaningful impact on the rate of economic growth. The composition of the government also has a comparatively modest effect on the economy as the U.S. government accounts for a relatively small share of the overall economy, around just 30%, compared to well over 50% in parts of Europe.
Presidents matter, but alone they can do relatively little
Presidents, of course, do matter, particularly when it comes to major initiatives such as the tax cuts implemented under President Ronald Reagan or the New Deal under Roosevelt. But the cooperation of Congress is as important since the president alone can implement relatively little. Consequently, it is more illustrative to look at not simply the returns on the stock market under different political parties, but the combination of the president’s and those of Congress. Policies devised when one party controls both branches of the government are likely to be very different than when compromise is necessary.
Since 1952, there have been 32 sessions of Congress under various presidents. The combination that has corresponded with the highest average return for the S&P 500 has been a Democratic president with a Republican Congress, with a 14.8% return on average, followed by a Democratic president and a split Congress, where no single party controlled both houses. Under this configuration, the average return was 14.0%. The combination with the lowest returns was a Republican president and a split Congress, averaging -4.3% (see exhibit 1 below). Of course these results should not be seen as having too much predictive value as there are far too few examples of each to be statistically significant. The top scoring combination has only occurred four times since 1952.
Exhibit 1: S&P 500 index returns under different US political configurations
Source: Factset, BNP Paribas Asset Management, data through 4 May 2016.
Sector returns under different political configurations
The impact of the political party composition of the government is difficult to separate from other macro factors; the business cycle does not follow the political cycle. There is, however, a more likely discernible influence on particular sectors of the market. Legislation can have a significant impact on an industry, with healthcare and the financial sector being two clear and recent examples. There is a somewhat more discernible pattern in the sector returns and the configuration of government than there is for the market overall. The healthcare sector has outperformed the S&P 500 whenever there has been a Democratic president and a Republican or split Congress, while it has done so less often when the president was Republican and Congress was either Democratic or split (see exhibit 2).
Exhibit 2: S&P returns and party of president and Congress
Source: Standard & Poor’s, BNP Paribas Asset Management. Data as of 3 May 2016.
Note: S&P returns are inflation adjusted. First letter denotes party of president, second letter denotes party of Congress. D=democrat, R=republican, S=split in Congress
Returns for the energy and materials sectors have been almost the opposite, underperforming the S&P 500 under Democratic presidents and Republican / split Congresses, but outperforming when the government was controlled by one party, either Republican or Democrat. Companies in the consumer staples sector generally did best with Republican presidents and Democratic or a split Congress.
The sector outlook for the next four years depends as much on the state of the economy as it does on who might eventually win the election. Regardless of the victors, the healthcare sector is likely to continue undergoing significant change and expanding its share of the economy. Which sub-industries will benefit and which will suffer will probably be determined more by politics, however. Returns for the financial sector, too, are likely to be driven primarily by the growth of the overall economy and particularly by Fed policy, as it seems unlikely the regulatory burden is going to lessen significantly, regardless of the election’s victors.
The technology sector is well positioned to expand under most political scenarios, and indeed in the past there has been little correlation between the sector`s returns relative to the S&P 500 and the composition of government. Technology is the most dynamic sector of the market, which bodes well for its own earnings growth. The sector will also benefit, however, due to the challenges facings companies in many other parts of the market. In an environment where nominal GDP growth is low and margins already high, companies are seeking new ways to cut costs and improve productivity. Technology companies should benefit disproportionately from this investment.
The results of the upcoming presidential election will likely have little impact on the trend of US economic growth, but individual sectors could well be impacted by the legislation that results. The best investment strategy, however, is to focus on those with the best earnings growth potential instead of the best lobbyists.
This article was first published in the Weekly Intelligence Report on 17 May 2016.