Introduction

Square-Off: Which Candidate Will Be Better for the Economy?

Apparently, there’s widespread dissatisfaction among CFOs about the choice between Hillary Clinton and Donald Trump for the next president of the United States. During an interview about last week’s CFO 2016 Presidential Election Survey, Steve Underhill, the treasurer and controller of R.O. Whitesell & Associates, seemed to sum up the views of many survey respondents: “I think it’s an absolute shame that in a country the size of ours and with the history of ours that we’re down ..

With Election Day just short of two months away, the lights of world media continue to shine on the turbulent U.S. presidential campaign. Much attention is devoted to the daily tactical moves of Hillary Clinton and to the daily tweets of Donald Trump. Only some attention is devoted to their strategic economic plans, and especially to whether Trump’s plan is internally consistent or anchored to reality.

Paolo Pasquariello

Paolo Pasquariello

Regrettably, even less attention is given to the implications of this unique presidential campaign and the significant political uncertainty it may be generating for U.S. and international financial markets. This may ultimately haunt us all, since evidence from past elections suggests those implications are likely to be particularly severe this time around in light of Trump’s inflammatory words and proposed deeds.

Many recent studies (including my own) show that political uncertainty plays a major role in explaining aggregate fluctuations of U.S. and global financial markets. There is considerable debate about whether elections are accompanied by significant asset price movements. However, there is consensus that political uncertainty makes financial markets significantly more volatile, especially in proximity to close elections or elections that may yield dramatic policy changes.

There are at least three reasons that election years magnify financial market volatility. First, greater political uncertainty in election years may magnify existing asymmetries between informed and uninformed market participants – since after all, better information is more valuable when there is greater uncertainty.

Second, greater political uncertainty in election years may magnify existing ambiguity among market participants about economic fundamentals affecting the value of financial assets. For instance, investors may be wondering about whether a Trump administration may help shore up the financial industry, given Trump’s wavering pronouncements. It is therefore not surprising that financial institutions generally tend to hedge their political bets by contributing to both sides. It is telling that, according to media reports, contributions are leaning Democratic in this election cycle, despite that party’s reputation for greater “hostility” toward Wall Street. Wall Street may prefer the certain (Clinton) to the uncertain (Trump).

Third, greater political uncertainty in election years may magnify the disagreement among financial market participants about economic fundamentals. For instance, investors may disagree about whether a Trump administration may support or unravel current efforts to regulate monopolies, to rein in “too big to fail” banks, to ratify international trade pacts, or reasonably address immigration reform. Trump’s latest, often off-the-cuff pronouncements on these topics are likely to fuel disagreement, rather than quell it.

All of these considerations may be of even greater relevance for “politically sensitive” industries, meaning those industries whose economic fortunes are more likely to be affected by political continuity or discontinuity (tobacco, mining, natural resources, guns and defense, utilities). Trump’s unwavering verbal support of the coal industry, despite its economic, technological, and environmental challenges, comes to mind.

My recent research with doctoral student Christina Zafeiridou shows that political uncertainty may also severely disrupt the “normal” functioning of financial markets. In particular, presidential campaign years are often accompanied by a significant deterioration of U.S. stock market liquidity – that is, of investors’ ability to trade their stocks quickly and cheaply. As trading volume shrinks, prices are more often stale, and the impact of trades on prices is larger.

That, in my mind, is perhaps the most worrying effect of this year’s political uncertainty, since it translates into a higher cost of trading for all market participants, regardless of their political leanings or financial circumstances. While perhaps paradoxical to some Trump supporters, their candidate’s behavior may in effect result into a tax on financial transactions.

There are signs that the presence of Donald Trump atop the GOP ticket may accentuate those historical patterns, for at least three reasons. First, Donald Trump continues to promise significant, yet often incoherent policy shifts, making it difficult for investors to formulate expectations about post-election policies. Second, Trump has yet to issue a single detailed statement on his proposed (or tweeted) economic policies. Lastly, financial markets are already plagued by significant uncertainty, given the prolonged effects of the Great Recession in Europe and economic and financial uncertainty in Asia.

Notwithstanding these doomsday scenarios, many polls suggest that the outcome of this presidential election may actually be not as uncertain as in past elections. The New York Times currently attributes Hillary Clinton a sizable 80% chance of winning the presidency. Investors may be troubled by the volatile back-and-forth of talking heads on cable news programs. Yet, a lot of entertaining television in the fall may not necessarily end up making for volatile and illiquid financial markets. Comes November, investors (and all of us) may breathe a sigh of relief.

Paolo Pasquariello is associate professor of finance at the University of Michigan’s Ross School of Business.

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