California-based investment manager Franklin Templeton and ClearBridge Investments discuss the investment, fiscal and policy implications of the US elections. 

Eyes are on the US elections in November, with everyone wondering whether the next president will be Democratic candidate Kamala Harris or Republican candidate Donald Trump.

According to Grant Bowers, portfolio manager at Franklin Equity Group, markets ultimately dislike uncertainty. “Right now, given that it’s a 50-50 toss-up, we have to look beyond that and think about what the markets are expecting from each candidate,” he said.

“Both candidates are relatively well known to the markets, so it's not surprising that we haven't seen a lot of volatility in the run up to the election. That said, I think there are some real differences between the two candidates on regulation, tariffs and fiscal policy. But with the most likely outcome being a split government, the chance of large-scale change is pretty low. And that's what you're seeing markets currently react to,” he added. “Now, if we see a sweep of one party taking control of the White House, the House of Representatives and the Senate, I think you can expect more volatility because if one party controls all three parts of the government, they're able to affect meaningful change.” 

“If you look at the way the market has performed recently, there is definitely some optimism for President Trump to win with his pro-business, low tax, low regulatory policies. Now the other side to that is what happens with tariffs and the impact around that, as well as the fiscal policies and levels of debt? You don't get all the upside without some of the potential downside,” Bowers said.

“Since 1932, the average annualized price return for the S&P 500 was 8.9 per cent when you've had a Democratic president and 5.6 per cent when you've had a Republican president,” Jeff Schulze, head of economic and market strategy at ClearBridge Investments, continued.

“But when you look at it from a longer-term perspective, a very different picture starts to emerge. For example, if you look at it since the day after the election, whether it's a Democratic president or a Republican president, and you look out on a 10-year time horizon, the returns for both parties are quite similar. If you look at Democratic presidencies on a 10-year forward-looking basis, the annualized return is 6.4 per cent, and Republican presidencies are 6.1 per cent,” Schulze said.

“More importantly, sometimes policy doesn't matter as much as the underlying economic backdrop. What matters more is…the state of the economy. And from all the metrics that we look at, we think the US economy is on a solid foundation at the moment. In fact, we've increased our odds of a soft landing to 85 per cent,” he continued.

“I think the market is still somewhat optimistic in terms of the rate cut hopes that it has built into the system. And in large part I agree the economy is set up to do quite well. If you do have a Republican sweep and you have some of the broader-ranging tariff measures put into place, this might limit to some extent the Fed's appetite for massive rate cuts because there is the potential for some inflation to come from it. Having said this…we don't think we're going to get the full range of across-the-board tariffs,” Sonal Desai, chief investment officer at Franklin Templeton Fixed Income, said.

“So far, US consumers remain pretty strong and we don't see that immediately changing on the back of the elections. Ultimately, I think what will impact consumer confidence and demand is going to be concern about the economic outlook, in particular jobs. Should the outcome of the election remain uncertain for an extended period after election day, this might have some impact,” she added.

“With a Trump presidency, we should anticipate that he will continue to speak on interest rates. However, he has come out and said he doesn’t believe he should have the ability to dictate those interest rates. The broader political pressure is something the Fed has lived with in the sense that every time US Federal Reserve Chair Jerome Powell goes up in front of Congress, he either gets beaten up by the Republicans or the Democrats. This is a time-honored tradition. I tend to believe more in the strength of the institution and therefore assume that the more dramatic changes that people are worried about are unlikely to come,” Desai continued.

“Generally speaking, in order to see a big movement in taxes or spending, you need to have a sweep scenario. If nothing is done, you're going to see a fiscal cliff, with almost every American seeing a higher effective tax rate. You also have some corporate provisions that are rolling off. If Harris wins with a divided government, she's probably going to push for a marginally higher corporate tax rate…in order to fund some of the lower-income cohort tax credits and additional social spending,” Schulze said.

“From a Trump perspective, if it happens to be gridlock, you're likely going to see him try to push further all of the tax cuts that are in the original Tax Cuts and Jobs Act in exchange for more spending for families, seniors and lower income people. These provisions are going to sunset at the end of 2025, so the markets really aren't going to price that dynamic in until the fourth quarter of next year. Ultimately, I think there's incentive for both sides of the aisle to come together and move forward on a legislative agenda,” he said.

“You are not going to get a massive change in fiscal direction regardless of the outcome of the election. We already have the Tax Cuts and Jobs Act in play, and if you had a Republican sweep, those tax cuts would probably get extended. From the Democratic side, there isn't much attention paid to the fact that there is a desire to keep the TCJA tax cuts for those making less than $400,000, which makes up three-quarters of the cost of that original measure,” Desai added.

“We would anticipate a greater degree of spending expansion in a Democratic sweep. That's not surprising but really the devil is in the details because, in the last few weeks, both candidates have thrown out new ideas. The fiscal deficit [that’s projected] is enormous. It doesn’t appear to come down below 7 per cent as a percentage of GDP, and it might be as high as 8.5 per cent. In peace time in a strong economy, it's pretty unprecedented to be looking at this scale of fiscal deficits,” she continued.

“I don't think you would see a dramatic shift in regulatory policy for big tech under a Republican administration. Where you would see an impact is areas like financials and energy, where deregulation can have a directional change from where we are currently with the Democratic administration,” Bowers said.

“Generative AI has been probably one of the biggest secular themes in the market over the last couple of years. We sit here in Silicon Valley so we actually truly have a front row seat on how companies are viewing it. Our opinion is that this truly is a major technology platform shift, on par with what we see saw with cloud computing, the rise of mobile or even the birth of the internet. And it has the potential to drive trillions of dollars of economic impact globally,” he added. â€śUltimately, this is going to show up in an application phase where the products and tools become more embedded in our everyday lives. This is where we think the real value is going to be generated from productivity gains and cost savings.” 

“The large tech companies have told us about their roadmap for investment over the next few years as they build out data centers to support these large language models. We don't see the election outcome having any impact on those building plans,” Bowers added.

“Interest rates are going to play a big part as well. In the last quarter or two, small and midcap names really picked up as the Fed started cutting rates and we saw other sectors take more of a leadership role in the market. The big factors are going to be policy shifts that favor small companies – regulation to spur innovation or investment into specific sectors such as domestic infrastructure, electrification or renewable energy. Even policy shifts in areas of technology like automation or robotics could lead to broader market participation,” Bowers said.

“Volatility does tend to move higher as presidential elections near. Since July 1, the Chicago Board Options Exchange's CBOE Volatility Index, commonly called the VIX is up over 50 per cent. This is what you usually see as you head toward an election. But what's interesting is that the S&P 500 has moved higher over the last couple of months. This equity run-up is at odds with what we normally see going toward an election. Traditionally, equities move lower heading into election day. What we've seen recently is actually pro-cyclical leadership. It appears that the markets are front-running a potential Trump presidency,” Schulze continued.

“If you get a Harris win, that would run counter to what the market's been pricing in over the last couple of weeks, which could create a little bit of market downside as some of this move starts to get priced out. So I think you could get an after-election opportunity to put money to work,” he added. 

“If I just look at Treasury yields, we've already started seeing movement as polls start pricing in a possibility of a Republican sweep, which several weeks ago seemed highly unlikely. And we are seeing a Treasury sell-off. That is an acknowledgement of the fact that budget deficits are expected to become a lot higher,” Desai said.

“If you have a Democratic sweep, you probably would get a bit of a relief rally in Treasuries. It might not be fully appropriate because, regardless of who wins, we're looking at very, very large deficits. But I think you might still see that in the hope that there would be some increase in taxes or something to counterbalance a little bit of the deficit,” she continued. â€śGiven the expenditure expansions under a potential Democratic sweep and some level of tax cuts under a Republican sweep, I would say the outlook is not one which is particularly favorable for the long end of the yield curve post elections." 

“Municipal bonds are an opportunity, but this is driven more by the fundamentals than by the elections. I think in any state of the world, currently, munis still look very interesting,” Desai concluded.