Clash of the Titans
Is Romney’s rhetoric on ‘Obamacare’ repeal just that, and Obama’s Keynesian-stimulus line misplaced?
By Per Wimmer and John Moore Stanley | Published Sep 26, 2012
It is interesting to speculate on the effects the US elections have on markets. Being a data-focused shop, we decided to check the received wisdom that, surprisingly, Democratic presidencies are better. We reviewed the data since the second world war and looked at the one-year and four-year market returns from the November elections.
Surprisingly, the results were quite sharply favouring the Democrats with average one-year returns of 14.7 per cent versus -0.2 per cent for Republicans. Similarly, four-year returns averaged 63.0 per cent for Democrats versus 26.2 per cent for Republicans.
So it looks like Mr Obama is ahead in the election stakes – but what differences could we really expect between the candidates? A number of the differences are purely rhetorical – such as Republican candidate Mitt Romney’s promise to repeal Obamacare’ – but there are quite sharp differences in broad economic policy.
Both candidates are faced with the twin political problems of high unemployment – now hovering at about 8 per cent, albeit down from a peak of 10 per cent – and, of course, the large and mounting US federal deficit.
Put crudely, Mr Obama’s solution is to create jobs through Keynesian stimulus spending and to work on the deficit by eliminating tax cuts for the wealthy. Longer term growth will derive from an increased focus upon education.
Mr Romney’s solution to both issues can be summarised as a supply-side economic programme, with corporate tax cuts, elimination of dividend and capital gains taxes for those earning less than $250,000, and elimination of the estate tax.
The two men also differ on monetary policy. Mr Romney has been sharply critical of the Federal Reserve’s quantitative easing policies. These policies have, arguably, led to the recent stock market rally such that this programme is clearly of great importance to investors.
Federal Reserve chairman Ben Bernanke’s term continues to January 2014 but, although the Fed is theoretically independent of the administration, things tend not to work out that way, and it is hard to see QE being as aggressive under Mr Romney.
Our view is that unemployment and the deficit (both in the US and other developed countries) are linked to a fundamental change in the terms of trade between the developing and developed worlds. Because of globalisation, manufacturing has shifted away from the developed world to lower-cost labour markets.
Unfortunately for the people previously involved in those industries – and lacking in broader skills – they are in severe danger of permanent unemployment. The issue for their more fortunate compatriots is how much money to give them to re-train – and how much to give them to live. The result is a natural tendency for an increased concentration of income and wealth (to those with skills) and more government deficits because the “deadweight” has become sharply higher.
If one believes this hypothesis, it does provide a framework for reviewing the likely success of the two policy options. Viewed through this prism, Mr Obama’s focus upon education seems correct (though frustratingly long-term) while old-fashioned Keynesian stimulus appears misplaced. Such stimulus tries to pretend that the real economy is just fine – and that spenders have just lost a little faith and merely need to be perked up.
In reality, the US economy needs to adapt to a new-world equilibrium and pretending this simply ain’t so does not solve the problem. Displaced workers have to re-train and/or accept that their wages have fallen. The question of how much to restore them to previous standards of living is purely political.
Again, if one believes in this terms-of-trade hypothesis, it is quite likely that average (or at last broad) real standards of living must fall in the developed world. There is no law that says each generation must live better – although politicians must always promise that they will. Possibly a number of goods being sold to developing countries were never worth what was being charged and those countries are now doing it for themselves.
Globalisation has certainly freed up some underemployed people in emerging countries and they are clear winners in the world system – but there will also be losers – particularly in the short-term. Many of these are located in developed markets where their lack of true economic value was concealed by favourable terms of trade.
This analysis has two implications. First, rational economic policies should be focused upon producing flexibility in the domestic economy. Secondly, if a (developed) economy is not competitive in world terms, its price (that is, exchange rate) must be allowed to fall.
In our view, it is no coincidence that continental European countries are having a particularly difficult time. Although the euro has not helped, it is the fundamental rigidity of their economy and inflexibility of their labour force that has produced the problems.
The US economy has demonstrated remarkable flexibility but, with regard to the exchange rate, we now can turn to the policies of Mr Romney. He appears to regard a strong dollar as a badge of pride for the US – and hence his opposition to QE. We see no problem with dollar depreciation and view it as simply another price change reflecting a different economic order.
More generally, the Republican Party has a problem. Along with the red meat, the jingoism and a view of the US that never was, the party must persuade 51 per cent of the voting electorate that their interests are best served by giving most of their money and wealth to a small elite.
This is a tall order and does not really exist in so transparent a form anywhere else in the world that we can think of. From an analytic view, given the almost impossible mission, the party is to be commended that it is still in the race.
Unsurprisingly, Republicans would rather not talk about economic detail at all but, if pressed, will come out with the standard supply-side gambit. Mr Romney is in this camp.
The argument essentially runs that if income and capital gains taxes are lowered, it will lead to growth and thus to greater revenue sources for the government. It seems to us that while the redistribution effects are certain, the growth is a maybe and the record on government deficits is distinctly poor. Government debt ballooned under former presidents Reagan and each of the Bushes, while it actually fell under Clinton and Carter.
As investors, if given a choice, we would rather not have either candidate. Neither side addresses the core issues. It looks as though we are stuck – probably with Obama – and think that the better of the two rather poor options.
A recent study by author and stock market analyst Robert Prechter (of Elliott Wave fame) took a different approach, his hypothesis is that social moods, as reflected by the stock market, have a powerful effect on US elections, with large (20 per cent in three years) stock market moves associated with landslide victories for the incumbent. The incumbent has a marginal advantage irrespective of stock market gains and the S&P was up 36 per cent in the three years to August of this year. Putting these two observations together makes President Obama’s prospects look good. This view is reinforced by bookmakers’ odds in the UK, which heavily favour Mr Obama. As a nation of market-driven folks the British seemingly place rather greater weight on people risking their own money than the talking-head political pontification brigade who get paid by the hour.
Per Wimmer is chief executive and John Moore-Stanley is CIO of Wimmer Family Office