US Strategy Weekly: Election Impact

As the presidential election nears, we would normally review the economic platforms of both presidential candidates and try to determine how election results might impact the economy and the stock market. However, this year both platforms seem more conceptual than concrete and both candidates have indicated they would cut taxes and spend federal money at a time when the budget deficit is at an all-time high. This is worrisome.

Platforms

In brief, Harris is targeting small businesses by proposing an increase in small business tax deductions and stimulating small business formation. She is also stating she wants to provide tax credits to middle- and lower-income families to make housing, groceries, child rearing and prescription drugs more affordable to all. To offset this, Harris plans to raise the corporate tax rate to 28%, raise the capital gains tax rate, and would likely let the 2017 Tax Cuts and Jobs Act expire.

Trump has implied he would eliminate taxes on tips, social security, and overtime pay, and keep the 2017 Tax Cuts and Jobs Act permanent. His campaign has focused on stimulating the economy as a way to raise revenue and a big part of this is to make the US an energy independent country by removing the current Biden/Harris restrictions and red tape on energy production. But most economists have focused on Trump’s talk of imposing tariffs on imports to the US, which nearly all economists indicate would be detrimental and inflationary.

To all this we can only state that any US President can suggest tax policy but only Congress can pass and enforce it. Therefore, the odds that any of these ideas will come to fruition are nil which makes most of this meaningless political rhetoric. But in terms of Trump’s tariff talk, it is a fact that Presidents can impose tariffs, and Trump did impose punitive tariffs early in his first administration. Nevertheless, inflation at the end of Trump’s term was 1.9% YOY, which economists appear to have overlooked. Most have analyzed Trump’s tariff rhetoric in terms of a static economy, while we live in a dynamic economy. Moreover, we think Mike Gallagher (former House Representative from Wisconsin from 2018 to 2024 and currently head of defense for Palantir Technologies Inc. [PLTR – $42.94]) said it best in an interview on CNBC’s Squawk Box this week, that Trump used the threat of tariffs as a negotiating tactic in his first administration and only imposed tariffs selectively to change behavior and improve the trade balance of the US. This reminds us of President Teddy Roosevelt’s foreign policy of “speak softly and carry a big stick.” In terms of increasing energy production, this can be done by a President by removing current restrictions on energy producers and it does not require Congressional approval.

All in all, this does not make analyzing the economic impact of the election any easier. In our view, whoever wins the election may not have the luxury of passing any bill in the current emotionally charged environment. From this perspective, the results of the Congressional elections could prove to be more important to the overall economy than who sits in the White House.

Deficits and Bond Yields

Whoever does win the presidential election may find their ability to tax and spend curtailed by an unforgiving bond market. There is a sense of this in the financial markets this week as the 10-year Treasury bond yield advanced from the 3.6% seen in mid-September to 4.2% currently. Bond yields jumped from 4% to 4.2% after the US Treasury announced that as of October 18, 2024, the US national deficit for fiscal year ending September 2024 was $1.83 trillion, the third highest on record. The 2024 deficit was $138 billion higher than the previous year’s deficit and represented 6.4% of the GDP. Total federal debt is now approaching $36 trillion and debt held by the public is close to $28 trillion, as compared to US GDP of $27.8 trillion. See page 5. White House estimates show deficits coming down in future years, but this seems unlikely given the current political environment. There is little doubt that the debt burden and high interest rates will be a problem going forward; and for this reason, the rise in long-term interest rates is disturbing. It is worth noting that the 10-year Treasury bond yield at 4.2%, is now trading above all its moving averages and broke above a downtrend line at 4.1%. In short, the technical pattern for yields is positive. See page 8.

The Consumer and Retail Sales

Retail sales beat expectations in September and grew 1.7% YOY from an upwardly revised 2.2% rise in August. Excluding autos and gas, retail sales grew 3.7%, which beat inflation. However, if we take a long-term view of retail sales it shows that on a seasonally adjusted basis, total retail and food services sales have only increased a total of 13% since the end of 2021. Moreover, using the Federal Reserve Bank of St. Louis series of retail sales based on 1982 dollars (adjusted for inflation), total retail sales have grown a mere 0.8% since the end of 2021. See page 3. Not surprisingly, real retail sales have been negative for 20 of the 33 months during the same period.

Negative real retail sales are one of many indicators that have been signaling a recession over the last two years, but retail sales growth has not been uniform among sectors. The big gainers since the end of 2021 have been food services and drinking places up a total of nearly 30%, nonstore retailers up 28%, health and personal care up 16.3%, miscellaneous merchandise stores up 12.4%, and general merchandise stores up 11.8%. Sales for motor vehicles and parts dealers have grown a total of 10% from the end of 2021, even though the longer-term sales trend has been decelerating since the end of 2019. Since the end of 2021 total retail sales have declined for gas stations, sporting goods/hobby/book and music stores, furniture and home furnishing stores, and building materials and garden equipment and supply stores. See page 4.

Technicals versus Valuation

The S&P Composite and Dow Jones Industrial Average have been setting a string of record highs in October and despite several days of weakness, all three major indices remain less than 1% away from their all-time highs. Even the Russell 2000 index has now gained 10% year-to-date and is less than 9% from its all-time high. By all technical measures, including our 25-day up/down volume oscillator, the equity market is demonstrating positive momentum as it approaches what is typically the best three performing months of the year (November, December, and January). See pages 9-12.

Unfortunately, valuation does not support equities at this juncture, but if this market is a melt-up or bubble, valuation will not matter in the short run. The SPX trailing 4-quarter operating multiple is 24.9 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.4 times and when added to inflation of 2.4%, sums to 23.8, which is at the top of the normal range of 14.8 to 23.8. By all measures, the equity market remains richly valued. And while LSEG IBES reports that 83% of companies are beating consensus estimates in this earnings season, it is worth noting that this week the LSEG IBES estimate for 2024 is $241.42, down $0.69, the estimate for 2025 is $275.62, down $0.48, and the guesstimate for 2026 EPS is $311.58, down $0.58. In short, equity prices have been rising, but in recent weeks earnings estimates have been falling for 2024, 2025, and 2026. This combination is unsustainable in the long run.

Gail Dudack

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