No matter who wins the election, the next U.S. president faces a budget problem

Christine Tan, CFA, Portfolio Manager, SLGI Asset Management Inc.

Many investors want to know how to position their portfolios to benefit from the outcome of the upcoming U.S. presidential election this November. While markets love to bifurcate between a “Biden-basket” and a “Trump-basket” of stocks and how they may perform, we think it may be short-sighted to use such a narrow framework to position portfolios.??

Of course, it’s important to stay vigilant about short-term market volatility. But we believe larger challenges, like America’s sizable budget deficit, will limit the agenda of the next U.S. president - no matter who wins.

No American President can transform the U.S. economy overnight

Market concerns around policy changes are often overdone in the short term. Policies take time to pass and take effect. Three recent key examples of this are: the Republicans passing the Tax Cuts & Jobs Act (2017), the Democrats passing the Investment Infrastructure & Jobs Act (2021) and the Inflation Reduction Act (2022).???

All these took at least a year to pass after the new president took office. Once passed, policies take time to implement. This means investors, companies and markets have time to assess the financial impact.

Adding fiscal fuel to an economy on fire

We believe the main challenge for investors will stem from the U.S.’ limited fiscal room to respond to an economic slowdown, rather than any immediate policy changes post the U.S presidential elections in 2024.??

Much of the “American exceptionalism” in growth since the COVID-19 pandemic has been due to continuing generous fiscal spending by the U.S. government. What’s potentially problematic about this generosity is that it has come at a time of strong U.S. economic growth. Typically, governments spend more when the economy slows and tighten their belts when the economy expands.

Source: Federal Reserve Bank of St. Louis, Macrobond. The grey bands in the chart above indicate periods of U.S. recession.

The Congressional Budget Office (CBO) estimates that the U.S. is running a US$1.92 trillion federal deficit in fiscal year 2024 even as the economy hums along with very low unemployment. The CBO projects the deficit to inch up to US$1.94 trillion (6.5% of GDP) in the fiscal year 2025.?

We think such high deficit levels will tie the hands of the next U.S. president and limit their options to grow the economy.

The U.S. economy: less sensitive to rate hikes and cuts?

When the U.S. economy hits a wall and stumbles, the U.S. Federal Reserve (the Fed) usually steps in by cutting interest rates.??

But it may not be that simple this time. One of the observations from the Fed’s interest rate-hiking cycle, which began in early 2022, is that the U.S. economy may be less sensitive to interest rate hikes or require more time to respond. Not even the Fed predicted that benchmark rates would need to climb to 5.5%, and stay elevated for so long, to bring inflation closer to target levels of 2%.??

This means that perhaps going forward, any rate cuts by the Fed may not have as big a stimulative effect to the U.S. economy as expected although equity and bond markets may rally.??

The term premium or the compensation that investors require for bearing the risk that interest rates may change over the life of the bond, spiked in late 2023 but remains lower than longer term historical levels. We think if U.S. deficits continue to be high, investors may demand higher term premium to hold long-term U.S. Treasuries. So, any short-term cuts to interest rates by the U.S. Fed may not produce a desired stimulative effect in the economy if long-term bond yields stay sticky due to higher term premiums.??

Because of the uncertain outcome of the elections and timing of meaningful policy changes, we feel investors should look through the noise leading up to the results of the U.S. elections. Over the long-term, we think investors will benefit by focussing on fundamentals such as a company’s competitive advantage, earnings outlook and valuations.?

Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any mutual funds managed by SLGI Asset Management Inc.?These views are subject to change at any time and are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.?

SLGI Asset Management Inc. is the investment manager of the Sun Life family of mutual funds. Sun Life Global Investments is a trade name of SLGI Asset Management Inc., Sun Life Assurance Company of Canada, and Sun Life Financial Trust Inc., all of which are members of the Sun Life group of companies.?

? SLGI Asset Management Inc. and its licensors, 2024. SLGI Asset Management Inc. is a member of the Sun Life group of companies. All rights reserved.