Deficit spending, a boost for AI, and what to expect post-election in the markets

There will be economic consequences to the 2024 election regardless of who wins the White House, but different industries and individuals will see varying effects, a panel of strategists and portfolios managers from Franklin Templeton said Wednesday.

No matter what, the deficit will likely be 7 percent or higher, stretching the national debt higher than its current level of nearly $35.8 trillion, panelists said.

“It’s a question of bad and worse. The fiscal deficit is enormous,” said Sonal Desai, portfolio manager and chief investment officer at Franklin Templeton Fixed Income. The scale of the deficit – given that we live in good economic times – is what should be so concerning, Desai said.

“The outlook is not one which is particularly favorable for long end of the yield curve, post-election,” she said.

Deficit spending was high during the Trump administration, despite promises to pay down the national debt. Part of the reason for that was the obvious need for spending to ward off more catastrophic fallout in the Covid environment, but the revenue reduction stemming from the Tax Cuts and Jobs Act was also to blame.

If Vice President Kamala Harris wins, Democrats will likely target only certain provisions of the act that are set to expire at the end of 2025, Desai said. Some of those cuts that could go away affect the wealthiest Americans and only represent a small fraction of a percent of gross domestic product, she said.

However, under a Trump presidency, some of the provisions most contested by Democrats will likely be extended, panelists said. Under a “red sweep,” in which Republicans would gain majority control of the Senate, retain a majority in House, and win the presidency, the Tax Cuts and Jobs Act provisions would all but certainly continue, with higher tax cuts possible for some, according to the panel. That would likely result in a higher deficit, they said.

But if Trump is elected and faces gridlock in Congress, he would likely negotiate for only some of the act’s provisions to be extended, in turn giving approval to maintain or increase social programs spending, which would also increase the deficit.

“You’re not going to get a massive change in fiscal direction, even under a Republican sweep,” Desai said.

However, the Committee for a Responsible Federal Budget forecasts a considerable acceleration toward the Social Security trusts’ insolvency before 2035 under Trump.

Former president Trump has been gaining in polls, and the markets appear to be pricing in a win for him next month, the speakers said.

However, the stock market stands to do well regardless of who is elected, they noted. What is unusual, currently, is how well the S&P 500 is doing leading up to the election, even as the VIX is up by about 50 percent this year, the latter of which is usual in an election year, said Jeffrey Schulze, head of economic and market strategy at Franklin-owned ClearBridge Investments.

“This equities runup is not typical of what we see ahead of an election,” Schulze said.

In the 10 days following an election, six are usually negative, although there have been only two negative S&P 500 observations three months out for the past 10 presidential elections, he said.

A contested election, such as in 2000, could move stocks lower for a short time, he said. In that case, the S&P 500 fell by about 10 percent, but that was exacerbated by the dotcom bubble burst – a more likely scenario if the election is contested this year would be a fall of 3 percent to 5 percent, he said.

Investors might think it’s a safe bet to consider the effects of lax regulation under Trump or more stringent regulation under Harris across different sectors – but don’t count on that, he said.

For example, health care stocks grew well following the passage and implementation of Obamacare, he noted. And energy was hardly booming during most of the Trump presidency, despite the favorable approach toward fossil fuels, he said.
“Energy was the worst-performing sector within his tenure.”

However, one area within that category is expected to grow, regardless of the election outcome: nuclear energy, said Grant Bowers, portfolio manager in Franklin Equity Group.

“It’s really one of the only ways we meet our carbon-zero, or net-zero, future and meet the need for electricity,” Bowers said. That demand is being increased by tech companies seeking more power to support their AI development and use – another area that stands to do well regardless of election outcome, he said.

By contrast, demand for oil is not increasing as significantly, which means that even a less burdensome regulatory regime – and expanded domestic drilling – may not mean much for the energy sector, he said.

“I’m not sure there is a lot of capacity to take up all this new production… You need a market to pay for it at a rate that is profitable,” he said. “Right now, a lot of the energy companies are in a shareholder creation mode rather than an increase-production-at-all-costs mode.”

A Republican sweep could hurt clean energy, with incentives from the Inflation Reduction Act likely being on the chopping table, the panel said.

On the issue of tariffs, the markets apparently are calling Trump’s bluff on a minimum 60 percent for Chinese goods, Bowers said. Levels that high could hike inflation and lead to slower growth, he said.

“We haven’t seen any sectors react really negatively to the tariffs,” he said.

Further, there could be a lag between tariffs and an effect on the US economy, under the “red-sweep” scenario, Schulze said.

“It’s probably not going to affect the US economy for a year,” he said.

Desai cited the 2016 election outcome and the lack of implementation of tariffs at the scale Trump had proposed.

Even so, “the US is effectively a large, closed economy,” she said. “Therefore, tariffs are more likely to impact more of its partner countries than the US itself.”