The politics of finance

Butterfield Market Watch, Eamon F. Cargo 

With the United States presidential elections coming up in less than a year, much of the news media is focusing on who will be the next president of the US for a good reason. Politics is big business, and the US boasts the world’s largest economy. The politics of the US greatly influence finance. That is why in 2007-2008 individuals, organisations and corporations donated in total about $1.1 billion to the 2008 campaigns of John McCain and Barack Obama (1).  

The US tax code drives certain behaviour. On an individual level, the tax code allows a deduction for mortgage interest, encouraging home ownership. There was also an inclusion that was passed so that up to a $250,000 gain on the sale of a home lived in for two of five years would elude taxation which encouraged the flipping of houses (2). This also drummed up a lot of business for real estate agents who could negotiate a 3-6 per cent commission on the sale of a home. These tax laws helped fuel a bubble in the US housing market.  

In 2003, a change to the US tax code re-categorised dividend income from ordinary income tax rates of up to 35 per cent, to a more favourable rate of 15 per cent (3). Effectively it provides an incentive for people to invest more in equities as opposed to fixed income, which can be taxed at more than double the rate.  

There are also subsidies given to certain industries due to political, as opposed to economic, reasons. Subsidies to farmers are rationalised for national security reasons. That is, if the US were to be attacked and food shipments to the country stopped, it could cripple the country relatively quickly.  

Another way the US government can influence corporations and their profitability is through legislation. What legislation is passed is significantly influenced by which party holds the office of the president in addition to a majority in the house and senate. The implications for corporations can be colossal, as seen since the 2008 presidential election. With a democrat-led Congress, Senate and president, monumental pieces of legislation were pushed through including the Affordable Care Act in 2010.  

The Affordable Care Act will require all Americans to obtain health insurance. The act ensures that in any state, large premium increases will be evaluated by unbiased experts to make sure they are based on reasonable cost assumptions and solid evidence. This analysis is expected to help moderate premium hikes and provide those who buy insurance with greater value for their premium dollar (4). This piece of legislation in its current form could hurt the performance of healthcare stocks in the long run by reducing their ability to increase premiums.  

With the upcoming election it might give your portfolio an advantage to analyse the agenda of each of the candidates to anticipate which industries might be impacted. It would also be worthwhile to see what each party considers the main issues, and how it might impact different industries and corporations.  

Republican presidents have typically favoured big business, low taxes and have opposed against organised labour. Large multinational corporations would benefit from the much discussed foreign tax holiday, which would allow favourable taxation on repatriated overseas profits. Think international consumer stocks (eg Procter & Gamble, Coca Cola). Corporations with high profits and margins (eg Exxon, Microsoft) would benefit from a more friendly tax structure. Domestically, manufacturing industries – heavily dependent on unionised employees – including carmakers (GM, Ford), airlines (United Continental, Southwest) and grocers (eg Safeway, Kroger) might be avoided. 

Equity investors seeking strong returns in housing and discretionary spending might hope for the re-election of President Obama. Continued Democratic leadership would likely continue to encourage domestic purchases, especially in housing/homebuilding (eg Lennar, Pulte), where initiatives are already in place to encourage banks to free capital. Commercial banks with heavy mortgage portfolios (eg Wells Fargo, JP Morgan) could be induced to place politics before profits, as deeper asset writedowns and risky loans would make banks less attractive.  

Historically, overall stock market returns favour a Democrat in the executive office. Therefore, investors more interested in a winning portfolio than in government policy might welcome another four years of President Obama. 

 

Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information. 
1) http://www.fec.gov/disclosurep/pnational.do
2) http://www.irs.gov/publications/p523/ar02.html#en_US_2010_publink1000200711
3) http://www.stern.nyu.edu/~adamodar/pdfiles/papers/divtaxes.pdf
4) http://www.healthcare.gov/news/factsheets/2011/05/ratereview05192011a.html 

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