Chief Investment Strategist
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Recessions have often coincided with the arrival of new US Presidents
Political risks for investors look higher than usual in 2016.
We highlighted this important point in our Mid-Year Outlook 2016 article entitled Politics: unusual times. One significant source of uncertainty comes from November’s US Presidential election. And whichever candidate wins this hotly-fought contest, history suggests that the arrival of a new President could coincide with difficulties for the economy and for financial markets.
Since the Second World War, there have been eleven recessions in the US – see table below. No fewer than eight of these have overlapped a new President’s first year in office. And going back to 1920, recession periods during a new US President’s first year have been three times as common as in other periods. Of course, this does not imply that Presidential elections cause recessions. But there are linkages between the business cycle and voting patterns.
As we argued in our article Outlandish outcomes in Outlook 2016, there’s been an overlooked tendency for the US electorate to choose Republican Presidents close to business-cycle peaks. And the electorate has also tended to opt for Democrats when the US economy has been depressed and ripe for recovery. This and some contrary examples, such as Reagan’s presidency, appear to explain the stronger growth readings and higher historic average stock market returns under Democrat administrations – see table below.
Despite voters’ tendency to opt for Republicans close to business-cycle peaks, current polling in so-called “swing states” implies a large Electoral College advantage for Hillary Clinton. This advantage is much greater than the differences popular vote support might imply – see table below. Such measures leave markets for the moment assuming no change in the status quo. However, even a Clinton win would come with a transition to an unknown, new US Congress.
Whatever the message of the polls, the Brexit result should make us feel less confident in the predictability of political events. And, the US economic recovery is at an advanced stage that shouldn’t be considered “shock-proof.” Further political uncertainty in 2017 therefore seems likely, whoever wins. What does this mean for our asset allocation?
In the absence of political shocks, we would expect equities to outperform fixed income returns on an absolute or risk-adjusted basis. Our new asset allocation – neutral global equities, underweight 1% in global fixed income – implies this. However, just as we adjusted our equity allocation somewhat lower in March of this year on the mere possibility of Brexit, US election risks encouraged us to err a tad cautious this month. You can read more about our latest tactical asset-allocation adjustments here.