2012 US Elections & Market Impact October 2012

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1 2012 US Elections & Market Impact October 2012

2 Historical Post Election Results 2

3 What Will Drive Elections & Markets? Extremely unique election year Election outcomes Resolution of fiscal cliff/budget crisis Election outcome and fiscal cliff/debt ceiling resolution must be considered in tandem 3

4 What are the Election Scenarios? 2012 Status Quo Turnover Sweep Increased Republican Mandate President Obama Romney Senate Democrat Republican Obama Republican Romney Democrat House Republican Republican Republican Likelihood 60% 10% 30% *Percentages subject to change as events unfold during final month leading up to election 4

5 Status Quo Obama Democratic Senate Republican House Effect on Equities: Neutral Market has begun to price in this scenario Equities may rally briefly on certainty of an Incumbent presidential victory Proposed increase in capital gains and dividends tax to 20% for those earning over $200,000 would be a negative for equities Effect on Corporate Debt: Neutral Spreads should remain tight regardless of election outcome Obama has ambitions to lower corporate tax rate from 35% to 28% Fiscal Cliff Resolution: Middle Road/Postponement Status Quo make up of legislature has shown little ability to tackle nation s budgetary or fiscal problems Political gridlock expected to continue Automatic Austerity a small concern given policymakers history concerning the debt ceiling Continuation of anemic growth and high demand for safe assets Republicans may be forced to make concessions upon realization of their lack of mandate 5

6 Turnover Sweep Romney Republican Senate Republican House Effect on Equities: Positive Stock market traditionally responds well to Republican congresses Romney seen as pro business may encourage firms to increase investment Effect on Corporate Debt: Positive Spreads should remain tight regardless of election outcome Romney looks to lower corporate tax rate, close loop holes, may be achievable with Republican controlled legislature Fiscal Cliff Resolution: Postponement Republicans unlikely to attempt for resolution during lame duck period and wait for new administration to take office Republicans would be able to pass a fiscal cliff resolution with favorable terms Without revenue increases, US debt ratings downgrade still a possibility, may not be economically healthy resolution Unlikely Republicans gain filibuster proof majority, would still have to negotiate terms with Democratic senate leaders 6

7 Increased Republican Mandate Obama/Rep. Senate OR Romney/Dem. Senate Republican House Effect on Equities: Positive Stock market traditionally responds well to Republican congresses Effect on Corporate Debt: Positive Spreads should remain tight regardless of election outcome Republicans would most likely block any tax increases on corporate debt Fiscal Cliff Resolution: Postponement/Middle Road Republicans may seek postponement to attempt negotiations with more favorable leverage Obama faces increased pressure to make concessions given increased Republican mandate Emboldened Republicans are able to win more concessions from Democrats, middle ground resolution is achieved May provide best basis for a credible resolution Automatic Austerity may also occur under this scenario if emboldened Republicans (especially Tea party Republicans) make unreasonable demands, and Obama refuses to concede before year end 7

8 Fiscal Cliff Resolution Scenarios Automatic Austerity Middle Road Postponement Resolution Full implementation of tax increases and spending cuts for January 2013, economic contraction Partial compromise avoids fiscal cliff but still resulting in fiscal drag on economy in 2013 Scheduled tax increases and spending cuts postponed until summer 2013, while policymakers search for other ways to reign in deficit Maintain US credit rating Growth continues albeit slowly Higher GDP growth in 2013 Increase in unemployment Unemployment falls albeit slowly Unemployment falls at greatest rate Results Treasury yields fall to % range Supports risk off assets Treasury yields remain in % range Supports risk on trade Treasury yields rise to around 1.8-2% range Uncertainty plagues the economy Flight to quality, credit spreads widen Consumer non cyclical, utilities, telecom/media resilient Continued housing sector improvement Credit sector financials perform well Credit cyclical sectors, especially consumer cyclical benefit Defense names come under pressure due to spending cuts Risks Double dip recession QE3 effects largely negated Market panic ensues Deflation Likely US Credit rating downgrade Budget deficit fails to be effectively addressed Agreement falls short of market expectations Ratings downgrade from Moody's, possibility of further S&P downgrade Budget deficit not addressed Global confidence erodes in United States ability to handle its finances 8

9 What to Expect Despite historical correlations to markets responding positively to certainty, a Status Quo scenario may provide a drag on growth because the certainty indicated may be only more political gridlock Outcome of senate races, particularly the degree of leverage gained by either party, may have greater impact on fiscal cliff resolution than outcome of Presidential race Markets are concerned with the resolution of fiscal cliff more than the outcome of elections Economic environment continues under the dark cloud of fiscal uncertainty well into 2013 Hunt for yield in high demand credit markets continues, Eurozone debt crisis continues to impede growth 9