The Outlook: October 2019 economic commentary
Political risks are rising in the US
With the November 2020 presidential election coming in to view, US politics threatens to add another element of uncertainty for financial markets.
Following allegations that President Donald Trump pressured the Ukrainian president, Volodymyr Zelensky, to launch an investigation into the business dealings of Hunter Biden with a view to discrediting his father, Joe Biden – a key contender for the Democratic presidential candidacy – the Democrats launched a formal impeachment inquiry on 24 September.
Impeachment is best seen as a political process rather than a legal one. Given that a vote to impeach a president requires only a simple majority in the House of Representatives, and the Democrats currently hold a majority in the lower house, the odds are that President Trump will be impeached. Betting markets currently attach a probability of around 70% to such an outcome.
However, impeachment does not automatically mean that the president would be removed from office. For this to happen, a two-thirds majority vote in the Senate, where Republicans outnumber Democrats by 52 to 46, is required to convict the president and force his departure from office. This looks unlikely: betting markets put the chance of Trump being removed from office at less than one in five.
The key question for investors is how the impeachment process might impact financial markets.
Lessons from history?
One way to answer this might be to look at how markets performed during previous impeachment inquiries. In December 1998, the House voted to impeach Bill Clinton, making him only the second US president to suffer such a fate (the first was Andrew Johnson, who was impeached in 1868). However, he was acquitted by the Senate in February 1999. Between the time impeachment proceedings started and President Clinton was acquitted, the S&P 500 – the main index of US equities - rose about 28%. Nevertheless, this favourable market performance had more to do with a rebound from the Asian Crisis, along with a nascent run-up in dotcom stocks, than domestic US politics.
Indeed, in contrast to the Clinton episode, equity markets were generally weak during the time of the Watergate scandal and the subsequent impeachment inquiry into President Richard Nixon (who was never formally impeached but resigned in August 1974). However, the 42% fall in the S&P500 during 1973-74 was primarily driven by the 1973 OPEC oil embargo and subsequent recession, not developments in Washington.
The lesson to draw from these observations is that the prevailing economic backdrop prevailing tends to be a much bigger factor in driving markets than the impeachment process per se.
In terms of the present state of the US economy, concerns about a recession have grown in recent months but, for now, GDP continues to expand at a trend-like pace, supported by solid consumer spending (see our September 2019 commentary). The impeachment process arguably heightens political risk and could potentially dent both business and consumer confidence. However, the bigger issue is likely to be how impeachment affects government policy and the outcome of the 2020 election.
Take policy first. Given that the impeachment inquiry will further polarise an already-divided Congress, the prospects for any bipartisan agreement on legislation during the next year have dimmed. In particular, the likelihood of any further meaningful fiscal stimulus ahead of the 2020 election looks increasingly remote. The government’s capacity to respond to a deterioration in the economic data is likely to be constrained, and investors expecting a repeat of the Trump tax cuts, which boosted corporate profits during 2018, are likely to be disappointed.
Another issue is how the impeachment process will impact foreign relations. The recent partial trade deal between the US and China arguably fits a narrative under which an embattled President Trump becomes less hawkish, in the knowledge that a damaging escalation in the tariff war could further dent his standing in the polls. Conversely, however, with Beijing sensing a weakened president, there is less incentive for the Chinese to make concessions which might usher in a broad-based agreement. In short, a big breakthrough regarding US-China relations looks unlikely.
The rise of Elizabeth Warren
As regards implications for the outcome of the 2020 election, the impeachment process also has the capacity to impact the race for the Democratic presidential nomination. Up until recently, Joe Biden - who was vice president under the former president Barack Obama - was the front runner to become the Democratic presidential nominee. However, while there is no indication that Biden has done anything illegal, his association with the impeachment inquiry, along with allegations of nepotism, threaten to tarnish his campaign. Indeed, Biden has recently lost his lead in some opinion polls to Senator Elizabeth Warren, and betting markets currently put her as the favourite to win the nomination.
Given Senator Warren’s left-wing economic agenda, this is potentially a big deal for financial markets. In general, Warren advocates ‘putting power back in the hands of workers and unions’ by improving workers’ rights, imposing higher taxes on ultra-rich households and big corporations, and curbing corporate power.
Warren’s proposals, if put into law, would potentially have large ramifications for specific industries. She has proposed breaking up the big tech companies, which she sees as having too dominant a position. This is significant given the outsized role that tech companies have played in driving US equity markets in recent years.
In the area of finance, Warren has chastised Wall Street and has proposed reinstating a version of the Glass Steagall Act, which would separate banks’ commercial and investment banking arms. In addition, she advocates reversing much of the financial deregulation enacted by the Trump administration. Elsewhere, Senator Warren has been critical of big pharmaceutical companies and also supports Medicare for all. As regards the energy sector, she has proposed a ban on fracking.
Under a future President Warren, there is unlikely to be an easing in relations between the US and China. Warren appears to share many of President Trump’s protectionist instincts, albeit with a more progressive nuance. Her “economic patriotism” agenda advocates that to trade freely with the US, countries will have to meet certain environmental, labour and human rights standards. It is doubtful that China would make the grade in this respect, and there is scant evidence that a Warren administration would roll back the tariffs that Trump has imposed on Chinese imports.
A potential headwind for US equities
Against this backdrop, it is perhaps not surprising that there is a growing concern amongst some investors regarding the prospect of a future President Warren. Clearly, a lot can happen between now and November 2020, and carrying out much of the Warren programme would require not only her securing the presidency but also the Democrats taking back control of the Senate, which prediction markets suggest is unlikely. However, if Senator Warren gains the Democratic nomination and President Trump’s poll ratings suffer due to the impeachment process and a slowing economy, we are likely to see some market volatility. President Trump has tweeted that if he were impeached “markets would crash.” This seems far-fetched. However, increased political risk threatens to become a headwind for US equity markets during the coming year.
This article is for generic information only and is not suggesting a suitable investment strategy for you. You should seek independent financial advice that takes your individual circumstances into account prior to proceeding with any course of action.