The US presidential election: immediate reflections on Mr Obama’s victory

Going into the election, there were comments that equities could suffer if Mr Obama were to be re-elected given Mr Obama’s proposal to raise the top rate of tax from 15% to 39.6% on dividends (for those earning more than $200,000 a year) and from 15% to 20% on capital gains, with both raised by a further 3.8% surcharge on investment income under Obamacare. If implemented in full, given that a third of the US equity market is owned by individual investors who earn more than $200,000 a year, these measures in principle take c5% off ‘fair value’ of the S&P 500, although much of this would in the price given that the election result was not a complete surprise. In addition, what happens in practice may be less extreme than the pre-election rhetoric, with scope for compromise. There is also a less well formed concern that Democrats are somehow less business friendly, but an Obama victory may make solving the fiscal cliff easier than a narrow Republican victory, and Mr Bernanke remains in favour at the Fed, which has been hugely supportive of the economy and markets.

In the near term, the policy focus will be on the fiscal cliff – addressing the significant spending cuts and revenue increases set to kick in at the beginning of next year, and extension of the debt ceiling will be required by early March. The key challenge is appropriation or assignment of resources for the different fiscal projects, as opposed to the authorisation of these projects. There are currently 13 individual appropriation bills that have been rolled up into a ‘Continuing Resolution’, which maintain the current level of Federal spending until the end of March 2013. Without the renewal of the appropriation bill, the Federal government would shut down.

There are then planned tightening measures: expiry of the Bush tax cuts (worth $294bn in calendar year 2013, or 1.9% of GDP) at year-end; expiration of employee’s payroll tax reduction ($126bn, 0.8% of GDP) at year-end; other revenue measures (the partial bonus depreciation allowance for capital investment, taxes related to Obamacare and other measures; $111bn, 0.6% of GDP); automatic spending cuts as a consequence of last year’s failed deficit reduction negotiation ($109bn, 0.7% of GDP) starting on January 1st; other spending reductions (unemployment benefits and reduction in Medicare payment rates for physicians; $50bn, 0.3% of GDP); and other tightening measures ($140bn, 0.9% of GDP).

Should the Bush tax cuts and payroll tax cuts expire they would create a combined fiscal drag of 2.7% of GDP or $420bn in the calendar year 2013. The automatic spending cuts that result from last year’s failed negotiations of Committee of Deficit Reduction, due to start on January 1st, would add an additional $109bn, or 0.7% of GDP. The entire fiscal cliff amounts to around $807bn or 5.1% of GDP of tightening, which would clearly push the US economy into recession.  However, such an outcome is seen by market commentators as unlikely and with the incremental tightening manageable, particularly given that the US private sector looks increasingly strong. Interestingly some analysts note that Mr Obama’s victory limits the influence of the Tea party and may make a deal on fiscal policy easier than it would otherwise have been and the context for all of this is that there is wide recognition that there must be a medium-term plan to reduce the deficit. Importantly, the US is effectively on a two-year political cycle, with a third of the Senate and all of the House of Representatives up for election every two years. This means that there is little incentive to cause a recession that would damage near-term future electoral prospects.  Furthermore, with yields so low, there is in effect no bond market pressure to tighten policy significantly. There is of course the precedent of President Clinton’s deal with the Republicans in his second term (with a Republican House and Senate) after lack of compromise in his first term had led to a government shut-down. There was also reasonable co-operation between the outgoing Bush administration and Obama in the 2008 lame-duck session.

Mr Obama’s victory can also be seen heading off risks that Mr Romney would have represented for markets. In particular, Mr Romney had indicated policies on China (with the threat to name it as a “currency manipulator” on the first day of his presidency), the Fed (opposition to Mr Bernanke and QE), spending on infrastructure and education, two areas crucial to the long-run growth rate of an economy, and R&D (Mr Obama’s said he would seek to expand and make permanent the R&D tax credit) that could have upset markets.

Looking forward, if there is a deal on the fiscal cliff, US corporate spending may be the main beneficiary, given that corporate confidence and investment already strongly reflect worries about the fiscal cliff, while consumer confidence has risen to the highest since February 2008. The US corporate sector is in excellent shape with record free cash-flow, low leverage, and any sign of a deal (or even just a six- to twelve-month extension) could lead to a bounce-back in productivity-enhancing US corporate spending.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla