US Presidential Election

Both the S&P 500 and the S&P TSX traded in a dead zone for the majority of the third quarter. With little change in the economic data reports and a seasonal decline in trading activity, volatility was nonexistent over the summer. Most of the third quarter increase in stock prices (S&P 500 +3.3%, S&P TSX +4.8%) occurred in the first ten days of the quarter.

Stock markets became increasingly volatile in the latter stages of September due to seasonality, an increased frequency of central bank meetings and a heightened focus on the impending US election. We expect this market uncertainty to persist as we await the outcome of the election. The incoming president (along with who controls the senate and the house) will define the US economic policies for the next four years.

Hilary Clinton is advocating increasing taxes on both income and capital. Donald Trump is proposing a larger fiscal stimulus, with lower taxes on capital, wages and corporate income. He also proposes a reduction in federal regulations. Clinton proposes financing the increased spending with more taxes on the rich. Trump’s budget assumes incremental growth from lower tax rates will drive an increase in tax revenues. Unfortunately, both candidates' plans would probably result in increased deficits. The Clinton plan would not raise sufficient revenues from increasing tax rates on the rich while Trumps’ plan is unlikely to see the necessary growth to offset his budgets incremental spending.

Presidential candidate platforms are nothing more than promises that may or may not be enacted. Proposed legislation and budgets still need to pass the House of Representatives. As we do not know which party will control the house and the senate it is impossible to say definitely what impact a Trump or Clinton victory would have on the markets and the economy. From a very short term perspective (think one to two weeks max), markets would behave better with a Clinton victory. She is perceived to be a more stable presidential candidate due to her being more of a "known" entity from her years in public service. Trump on the other hand is more of a wild card, as he has never served in public office and his policies are vague and constantly changing. The only thing we can state with a high degree of confidence is that a Trump victory should be positive for the stock market through year end while a Clinton victory would be bearish through year end.

Canadian economic growth has been quite subdued this year while the Canadian equity market has been one of the better performers in the developed market. This is due to the rebound in oil prices and the Canadian economy stabilizing and not entering a recession as originally feared.

Bonds continue to provide safety with respect to a return of capital, but with expectations for a minimal return on capital. Bonds (as measured by the Dex Bond Universe) returned 0.2% during the quarter. Abnormally low bond yields will continue to result in low returns assuming no material change in interest rates. Stocks will continue to provide returns that are greater than bond returns, although with a higher degree of volatility.

The current “recovery” is now in its eight year. Since the end of the Second World War, expansions have typically lasted between two and ten years. This expansion has been the most anemic since the end of the Second World War. While we currently see few signs that the current expansion is nearing an end, there is also no reason why the current sclerotic growth could not continue beyond ten years.

Low interest rates (monetary policy) have been the driving force behind the global expansion. Countries in the developed world have piled on debts even as government spending (fiscal policy) has subtracted from economic growth. For the first time since the recession, fiscal policy across the developed world is turning more stimulative. Political populism has pushed fiscal deficits down the list of political priorities. Tax cuts and working class benefits have become politically more important. This is evident from the platforms of both US presidential candidates and from the policies of the Federal Liberals during the last Canadian election.

While the scale of the fiscal stimulus is modest in dollar terms, it does signal a profound shift in government policies with respect to stimulating growth. This change is positive as central bank tools for inciting growth are reaching their limits. A portion of the growth in fiscal spending (and debts) is being supported by the low interest rates policies of central banks reducing the cost of servicing the growing government debt.

With tepid economic growth and valuations being pricey we expect increased volatility to be the norm. During the fourth quarter, this will likely be compounded by the US election. We continue to believe that economic growth and earnings are poised to accelerate, providing the framework for a positive stock market. Stocks should continue to out perform bonds. It also goes without saying that any deviation from these expectations would result in significant fluctuations in both stock and bond prices.