US Election Spotlight – Franklin Templeton

California-based investment manager Franklin Templeton and ClearBridge Investments discuss the investment, tax and political implications of the US election.

The focus is on the US elections in November and everyone is wondering whether the next president will be the Democratic candidate Kamala Harris or the Republican candidate Donald Trump.

Ultimately, markets don't like uncertainty, according to Grant Bowers, portfolio manager at Franklin Equity Group. “It's a 50-50 split at the moment, we need to look beyond that and think about what the markets expect from each candidate,” he said.

“Both candidates are relatively well known to the markets, so it is not surprising that we did not see much volatility in the run-up to the election. Still, I think there are some real differences between the two candidates.” But since the most likely outcome is a split in the government, the likelihood of large-scale change is quite low. And that's what markets are reacting to right now If we see one party take control of the White House, the House and the Senate, I think we should expect more volatility because when one party controls all three branches of government, they can bring about significant change.”

“If you look at how the market has been doing lately, there is definitely some optimism that President Trump will win with his pro-business, low tax and regulatory policies. On the other hand, what happens with tariffs and their associated effects, as well as with financial policy and the level of debt? “You don’t get all the benefits without some potential downsides,” Bowers said.

“Since 1932, the average annual return of the S&P 500 has been 8.9 percent if you had a Democratic president and 5.6 percent if you had a Republican president,” says 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 emerges. For example, if you look at the day after the election, whether it's a Democratic or Republican president, and look at a 10-year time horizon, the returns for both parties are pretty similar. If you look at Democratic presidencies over a 10-year period, the annual return is 6.4 percent, while Republican presidencies are 6.1 percent,” Schulze said.

“More importantly, sometimes politics is not as important as the underlying economic backdrop. What’s more important is… the economic situation. And based on all the metrics we look at, we believe the U.S. economy is on solid footing right now. In fact, we have increased our probability of a soft landing to 85 percent,” he continued.

“I think the market is still reasonably optimistic about the rate cut hopes that it has built into the system. And overall, I agree that the economy will do quite well. If the Republicans actually pull off a victory and some of the broader tariff measures are put in place, that could limit the Fed's appetite for massive rate cuts to some extent, as some inflation could potentially result. However, we do not believe we will get the full range of flat rates,” said Sonal Desai, chief investment officer at Franklin Templeton Fixed Income.

“So far, US consumers are still quite strong and we do not expect this to change immediately following the election. Ultimately, I think concerns about the economic outlook, particularly jobs, will impact consumer confidence and demand. If the outcome of the election remains uncertain for an extended period after Election Day, this could have some impact,” she added.

“With a Trump presidency, we should expect him to continue talking about interest rates. However, he has spoken out and said he doesn't believe he should have the ability to dictate these interest rates. The Fed has lived with the general political pressure in the sense that every time Federal Reserve Chairman Jerome Powell goes before Congress, he gets beaten up by either the Republicans or the Democrats. This is a time-honored tradition. “I tend to believe in the strength of the institution and therefore assume that the more dramatic changes that people are worried about are unlikely to happen,” Desai continued.

“In general, you need a broad scenario to see a big move in taxes or spending. If nothing is done, there will be a fiscal cliff in which almost every American will experience a higher effective tax rate. There are also some company regulations that come into effect. If Harris wins with a divided government, she will likely push for a slightly higher corporate tax rate … to fund some of the tax credits for lower-income cohorts and additional social spending,” Schulze said.

“If there is a gridlock from Trump's perspective, you will likely see him try to further push all the tax cuts that were in the original Tax Cuts and Jobs Act in exchange for more spending for families, seniors, etc. People with lower income. These provisions will expire at the end of 2025, so markets will not price in this dynamic until the fourth quarter of next year. Ultimately, I think there is an incentive for both sides to come together and advance a legislative agenda,” he said.

“Regardless of the outcome of the elections, there will be no massive change in financial policy. We already have the Tax Cuts and Jobs Act in place, and if Republicans passed it, those tax cuts would likely be extended. “Not much attention is being paid from the Democratic side to the fact that there is a desire to maintain the TCJA tax cuts for those making less than $400,000, which accounts for three-quarters of the cost of that original measure,” Desai added.

“We would expect a greater increase in spending if the Democrats win the election. This is not surprising, but the devil is in the details, as both candidates have put forward new ideas in recent weeks. The budget deficit (which is projected) is enormous. The percentage of GDP does not seem to fall below 7 percent and could even reach 8.5 percent. “In peacetime and a strong economy, it is quite unprecedented to see such levels of budget deficits,” she continued.

“I don't think there would be a dramatic shift in regulatory policy for big tech companies under a Republican administration. “You would see impacts in areas like finance and energy, where deregulation can create a change in direction compared to the current state of Democratic government,” Bowers said.

“Generative AI has probably been one of the biggest secular themes in the market in recent years. Sitting here in Silicon Valley, we really have a front row seat to how companies see it. In our opinion, this is truly a major technological platform shift, comparable to what we've seen with cloud computing, the rise of mobile or even the birth of the Internet. And it has the potential to generate trillions of dollars in economic impact globally,” he added. “Ultimately, this will become apparent in an application phase in which the products and tools will be more integrated into our everyday lives. This is where we believe the true value is generated through productivity improvements and cost savings.”

“The big tech companies have told us about their investment plan for the next few years as they build data centers to support these large language models. “We do not see the election results impacting these construction plans,” Bowers added.

“Interest rates will also play a big role. Over the last quarter or two, small and midcap stocks rallied significantly as the Fed began cutting rates and we saw other sectors take more leadership in the market. The big factors will be policy changes that favor small businesses – regulation to spur innovation or investment in specific sectors such as domestic infrastructure, electrification or renewable energy. Even policy changes in technology areas such as automation or robotics could lead to broader market participation,” Bowers said.

“Volatility tends to increase as the presidential election approaches. Since July 1, the Chicago Board Options Exchange's CBOE Volatility Index, commonly referred to as VIX, has risen over 50 percent. This is what you typically see as you head into an election. What is interesting, however, is that the S&P 500 has risen in recent months. This rise in stocks is at odds with what we typically see leading up to an election. Traditionally, stocks tend to trend lower at the start of Election Day. What we have seen recently is actually pro-cyclical leadership. It appears that markets are anticipating a possible Trump presidency,” Schulze continued.

“If Harris wins, it would be at odds with what the market has been pricing in over the last few weeks, which could lead to a slight market decline as some of these moves begin to be priced out. So I think there could be an opportunity to put money to work after the election,” he added.

“If I just look at Treasury yields, we are already seeing movement as polls are starting to price in the possibility of a Republican victory, which seemed highly unlikely a few weeks ago. And we are seeing a sell-off in government bonds. “This is a recognition of the fact that fiscal deficits are expected to get much higher,” Desai said.

“If you were to take a Democratic win, you would probably see some sort of recovery rally in Treasuries. It may not be entirely appropriate because regardless of who wins, we face very, very large deficits. But I think you could still see that, hoping there's a tax increase or something to make up the deficit a little bit,” she continued. “Given the spending increases in a possible Democratic victory and some tax cuts in a Republican victory, I would say the outlook for the long end of the yield curve post-election is not particularly favorable.”

“Municipal bonds are an opportunity, but it is driven by fundamentals rather than elections. I think munis still look very interesting in every state in the world right now,” concluded Desai.