US contenders box clever

As Obama and Romney fight their corners in the US presidential elections, they are showing clear differences in their views, with a conservative Obama aiming to achieve a fair balance between spending and revenue and Romney mounting a stance as an aggressive reformer. Whatever the outcome of this bout, it carries implications for investors, writes Vanessa Drucker

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Every twist on the US political stage carries implications for investors.  Republicans and Democrats have committed to singular economic views and promises – only some of which they will be able to enact.  The winner of the presidential race, and multiples victories and defeats in the Congress will determine financial opportunities and risks, and the shape of legislation to come.

That said, trying to narrow the precise arguments and party platforms can be frustrating.  American campaigns routinely may appear vague as an intentional strategy.  The political races tend to focus more on character than positions. Hence, candidates “surround themselves with consultants, who issue rosy statements about their own views and negative remarks about their opponents, almost always around broad themes,” says William Salka, a political science professor at Eastern Connecticut State University.

Yet this election is the first in some while in which competitive candidates are articulating clear differences.  In general, US politics veer to the center.  This time, however, the economic crisis and the debt mountain have provoked more drastic responses.  With its constitutional emphasis on a separation of powers, the US political system is not well designed to reaction to problems until they become urgent. “Now the economy has pushed us into a debate at the national level about the best solution,” Salka reasons.

The presidential candidates represent a sharp philosophical divide.  Obama, on the left, is actually the more conservative, in that “he is trying to achieve a fair balance between spending and revenue while maintaining as much of the status quo as possible,” notes Alain Sanders, a political science professor at St Peter’s University, New Jersey. 

Romney, on the other hand, is mounting a stance as an aggressive reformer, but a reformer who wants to go in a fiscally conservative direction.  Romney places faith in free markets, and believes the role of government should be minimal.  He argues for the rights of liberty and property, harking back to the ideas of John Locke on what a government should provide.  Obama, on his side, focuses on equality and fairness, and is willing to use the federal government, not to stifle liberty, but to level the playing field.   “He stands for a more modern liberalism, like that of Franklin D Roosevelt,” Sanders describes.  “He wants government to act as a trapeze net so that peoples’ circumstances never fall below a certain level.”  

The only area is which both candidates have been patently clear in their proposals is that of tax rates.  “On every dimension, the president would advocate higher tax rates than Romney,” states William McBride, the chief economist at the nonpartisan Tax Foundation. 

In a nutshell, Obama wants to raise the tax rates for the top two tiers of income to 36 per cent and 39.6 per cent, respectively.  On his own website the president describes how he would want millionaires to pay at least the same share of their income as a middle class family would. Romney would like to drop all tax rates by 20 per cent, which means today’s current top rate would fall to 28 per cent.  The contender has announced he would curtail deductions, credits and exemptions for the wealthy, Sanders adds, “but he has never specified how.”

It is especially significant for investors how the candidates approach dividend and capital gains taxes.  First, Romney wants to eliminate dividend, interest and capital gains taxes altogether for families who earn less than $200,000.  It is interesting that aspect of his proposals has received relatively little attention. 

David Twibell, president of Denver-based Custom Portfolio Group, reports that most of his own clients are not even aware of the proposal.  Yet, if enacted, it might have a pronounced impact on luring individuals back into the market.  A huge section of the public, which has abandoned equities, has so far been unwilling to participate in the market rallies, having been bruised by two crashes over the past decade. 

Obama, in contrast, is taking aim at dividend payments for the wealthy.  His website reads, “instead of a 15% tax rate, dividends will be taxed like regular income, and that means subject to the 36% rate above $241,000 and 39.6% above $390,000.”  He would also raise the rate on capital gains to 20 per cent, while maintaining the current levels at 15 per cent for those who earn less than $200,000. 

That outcome would not portend well for dividend paying stocks, like Philip Morris, Kimberly Clarke or Proctor & Gamble.  Most of those dividend-gushers have reached high valuations compared with the rest of the market; investors, including retirees, have flooded in to use them as substitutes for fixed income instruments. 

Per Timothy Ghriskey, the chief investment officer at The Solaris Group, says: “There could be some significant selling of all equities, including those that have done best and have the biggest capital gains.”

We may even see a wave of anticipatory selling immediately after the election.  “Once people know rates are due to skyrocket, they would be foolish to wait until January 1, to take gains,” warns Dick Dickson, a senior market strategist for Lowry Research. 

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Both candidates share a desire to lower corporate income taxes.  “Our own study, at the Tax Foundation, shows that that they are the most harmful to economic growth,” says McBride. On a global basis, “the U.S. is completely out of the running,” McBride adds.  Neighboring Canada, which has been steadily reducing corporate tax rates, has arrived at 25 per cent; the UK is aiming for 22 per cent in the next couple of years; and Ireland only takes 12.5 per cent. Romney would slash from a current 35 per cent to 25 per cent, whereas Obama would lower them to 28 per cent. 

Another dividing issue is the corporate tax on multinationals.  While Obama advocates preserving a tightened version of the current system, Romney has proposed a territorial system, exempting foreign income (which is how most industrialised countries do treat their multinationals).

How would an overall Republican or Democratic win affect economic conditions and investments? Starting with the Democratic side, which US sectors are most likely to benefit, if that party gains the upper hand?

First, the myriad aspects of infrastructure enterprises may prosper, such as materials, construction companies, cement, gravel, steel and all the other building components.  Obama has frequently clarified that he is not opposed to federal spending that might support economic growth and services, which might involve bridges, roads, rail, airports or public transport.  Housing, including new home building, might also benefit under a second Obama term, according to Twibell. 

He says: “The President has voiced his support for the Federal Reserve’s current monetary policy, which is designed to keep short-term interest rates and mortgage rates low for an extended period of time.” That low rate environment provides a positive backdrop for homebuyers and may help to continue reducing the supply of homes, paving the way for increased new construction. At the same time, real estate tax shelters might well return into vogue, as protection against some of the higher taxes.

Healthcare companies, which run the gamut from hospitals and professional providers to insurance companies, are likely to fare well under Democrats.  The version of the Affordable Care Act (so-called Obamacare) that eventually passed into law, and was later partially ratified by the Supreme Court, had already been dramatically watered down, with concessions to the pharmaceutical industry. 

As Salka points out, “the healthcare industry is actively lobbying to preserve the legislation.  They foresee huge growth, with the vast majority of 330 million Americans now covered.  They are even building new medical schools all over the country!” It is true that the pharmaceutical industry could come under increased regulation from Congress. Another targeted sector is that of firms that make articles like surgical tools, oxygen tanks or wheelchairs.  Under the ACA, the device manufacturers will begin to pay a 2.3 per cent surtax on those instruments as of January 2013.

Among other asset classes, precious metals and hard assets in general should perform well under the Democrats’ aegis.  The Federal Reserve, with the administration’s backing, has promised to keep interest rates ultra low until employment picks up. 

“The perception, if not the reality, is that under such a monetary policy inflation pressures will build,” says Dickson. People will react by buying gold, and some silver.  Low rates imply the continuation of a weak dollar policy, too, “although they’ll deny that until the cows come home,” Dickson adds.  Thus, low interest rates and a feeble greenback also grease the skids for higher commodity prices. 

Switching tack, a Republican ascendancy would carry distinct consequences.  Romney has indicated he may ‘retire’ Ben Bernanke, when the Fed Chairman’s term expires in 2014.  He has also made clear that he favors a tighter monetary policy, which could lead to diminishing economic growth over the short-term. 

“A reduction in government spending could negatively impact companies in the defense, technology and healthcare sectors in particular,” says Twibell.  “Interest rates may move up as the Fed takes its foot off the brake,” comments John Graves, a financial planner in Ventura, California.  “Rising rates, in an inflationary setting, could benefit Reits (real estate investment trusts), dividend stocks and laddered bank certificates of deposit.”

Among sectors, energy and power seem most likely to bless a Republican win.  That party would be more encouraging toward natural gas exploration and hydrolic fracturing, or “fracking,” as well as opening new land in the West and in Alaska to oil drilling.

“If Republicans get in, exploration and production industries would benefit, especially domestic firms, like Devon, Apache and Andarko,” Dickson suggests. The Keystone Pipeline project, intended to transport synthetic crude from the oil sands region in Alberta, Canada, has stalled under the current administration. Obama, however, has been a forceful champion of various alternative and renewable energy projects, such as solar, wind and biofuel, and those areas would continue to receive Democratic support. 

“There may be a case that Romney would be more supportive of building liquid natural gas (LNG) terminals, which are being upheld pending administrative review,” says Jonathan Wood, associate director, Global Analysis at the consultancy Control Risks.  Currently, US gas prices are about 10 per cent of those in, say, Japan, and producers assert they could sell far more if they were allowed to export the product globally. 

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Authorisation to build terminals has been delayed, while the government assesses the potential impact and the contention that permitting exports might raise domestic prices.  Members of Congress from states like Texas, Louisiana and Oklahoma have requested the administration accelerate the process.  “Many of these states will swing Republican, and carry more weight under a Romney administration,” Wood explains.

The Environmental Protection Agency would probably be less assertive under Republicans, which would lead to more narrowly tailored rulemaking and more authority delegated to individual states. Significantly, the EPA has introduced a rule to cut down on sulphur dioxide and nitrogen oxide generated by coal powered plants.  Some federal circuit courts have already held that the EPA exceeded its authority in this and other areas, and the case will probably go to the Supreme Court. 

“A Republican administration might simply roll back the rulemaking process, which would benefit both the coal power sector and big energy producers,” Wood predicts.  Coal stocks have been sold off so steeply, that “you’d have to believe most of the industry won’t be around in a few years,” Twibell adds.  If Republicans take control, companies might be keen to acquire those cheap companies, along with oil servicing firms, to a lesser extent. 

The defense industry would favor a Republican triumph, since the party is more attuned to increasing military spending.  Contractors, such as Lockheed Martin, Raytheon, General Dynamics and Northrop Grumman have all discussed laying off thousands of workers, in anticipation of impending cuts to be imposed.  “They are worried that Congressional sequestration of funds and the fiscal cliff will cause defense installations in the US to close,” Dickson says.

Republican success could prove a two-edged sword for financial services.  On the one hand, it might slow the implementation of Dodd-Frank, the complex new framework for a regulatory regime, which still requires rulemaking for dozens of provisions.  That delay would prolong uncertainty in the industry.  Romney has actually backtracked from his original vow to “repeal and replace” Dodd Frank, and recently conceded during the first presidential debate that “some parts of it make all the sense in the world.”  Since he has not specified his plan for reforms, the picture would remain cloudy for some time. 

On the other hand, some activities might become more attractive if Republicans relax regulations.  Wood cites commodity derivatives, such as energy and agriculture, which were targeted for increased oversight in the mind of Dodd-Frank drafters.  After oil and food price spikes in 2008, concern for market manipulation led to proposals for tighter limits on traders.  Republicans have long sought to roll these back.  Wood points out that rollbacks “might even impact how banks allocate resources, and whether they put trading arms in New York or London.”

Indeed, whoever becomes President will have executive authority to shift direction or emphasis in policy. For instance, Romney could not abolish the EPA, but he could direct the agency to craft less stringent rules.  Yet what Americans follow keenly, and foreigners may sometimes fail fully to appreciate, is the importance of the composition of Congressional seats up for election along with the presidency. 

After decimating losses in the 2010 midterms, Democrats lost control of the House of Representatives (240 versus 1990 seats) and only narrowly maintained an edge in the Senate (51 versus 47 seats).  Because the presidential election results are likely to be close, and neither party will enjoy a decisive upper hand, Congress will play a key role in enacting or repealing laws.  “Whichever side loses will still feel it almost won, so it will be very much alive and kicking,” Sanders observes.

It happens this year that Democrats are defending far more seats than Republicans.  In every two-year cycle, one third of the Senate is up for election.  This time, the majority are Democrats.  By sheer numbers, those incumbents are more vulnerable, who must also run against a weak economy.  As a general historical rule, about 90 per cent of House and 80 per cent of Senate incumbents do get re-elected.

Per Sanders says: “House districts are much smaller and homogenous, with fewer interests and divisions.  So there’s more chance for an incumbent’s voting record to antagonise the constituency.”

If Republicans should prevail across the board – supposing  Romney wins, while his party retains the House and picks up some seats in the Senate – what would that spell for investments? It would certainly point to more conservative outcomes.  Republicans tend to be more unified in their voting patterns anyhow, and include a large number of Tea Party conservatives, elected in the 2010 midterms.  “We’ll see a shift toward more big business-friendly votes,” says Salka. “Remember, big business spent millions to get Romney elected.”

If the same party wins both the House and the presidency, that would augur well for stocks.   “But gridlock would be negative for risk assets,” notes Adrian Cronje, the chief investment officer of Atlanta-based Balentine.

That may seen counterintuitive – Wall Street normally prefers that policy makers get so paralysed they cannot interfere.  “In this case, gridlock raises the probability of kicking the can on the deficit and employment, which is the worst outcome,” Cronje considers.

Markets are primarily looking for economic growth, whichever side wins the presidency or the Congress.  Two key issues of employment and the deficit determine that growth; they are often presented as mutually exclusive, but are actually linked, according to Cronje.  The dichotomy is normally expressed as a choice:  the deficit must expand in order to create more jobs.  A decline in the unemployment rate, however, will reduce the deficit because of the increase in tax revenue. 

“The person who will move the needle is the one who focuses on incentives to create jobs over the long term,” Cronje declares.

Sadly, none of the political platforms has sufficiently discussed a critical issue, namely the rate of new business formation for small-to-midsized firms.  Cronje notes, “it is running at the lowest pace ever in any recovery.  And those that have been created are employing fewer people.”

Both candidates express a lot of platitudes about the US having the most innovative economy in the world, and how technological advantages drive the profile of GDP.  So why not invest more actively in research and development, with a view to generating jobs?  “The market would be all over a candidate and party that did so,” Cronje promises.

The game-changing technological developments in fracking natural gas provide such an illustration. “The US has finally turned the corner from being an energy importer to being an energy exporter,” says Chris Faulkner, the CEO of Dallas-based Breitling Oil and Gas, who fears Obama might “squander” the bonanza of US energy reserves.

“Our burgeoning energy sector will provide high-paying jobs, it will boost the manufacturing sector, it will lower utility costs, and it will lower transportation costs, which will, in turn, have a favorable impact of the cost of delivered, consumable goods. As an energy exporter, the US can now attack overpriced European and Asian markets by offering a competitive deliverable to Russia and the Middle East.”

From another perspective, Romney’s more belligerent stance in the international arena may pose some long term dangers.  In particular, his hardline position on China could spin out of hand.  Although it is often dismissed, do not discount the risk that we might eventually see the Chinese manipulate their purchases of US treasury debt.  More immediately, a tariff war would not be in the interest of either country.  “In our symbiotic relationship, both economies need to move in the same direction,” says Twibell.  “A shouting war doesn’t help anyone!”

Whichever candidates prevail will face a raft of challenges.  A fiscal cliff looms, threatening to derail a halting recovery.  The national debt mounts into trillions, with strings attached to every dollar of the budget. Exceptional animosity cleaves the political ranks. After a long campaign season, it will be high time for the winners to move beyond posturing and empty promises to put the country back on a solid footing.