Obama vs Romney 2012, Fiscal Cliff Timeline

7/31/2019 Obama vs Romney 2012, Fiscal Cliff Timeline

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Goldman Sachs Global Economics, Commodities and Strategy Research 3

Top of Mind Issue 5

The fast-approaching US presidential election is perhaps one of themost important in recent history, with the fate of near-term USeconomic growth, medium-term US fiscal stability (and, with it, theUS sovereign debt rating) and monetary policy hinging on theoutcome, as discussed by our Washington DC political expert, Alec

Phillips, in Why the 2012 election matters more than most. Withthe race abruptly shifting from a likely Obama victory andpotentially a convincing one into a neck-and-neck race followingthe momentous first debate between the presidential candidates,the US election on November 6 is clearly Top of Mind.

To address this topic, we sit down with David Gergen a CNNpolitical analyst and Harvard Kennedy School Professor who hasadvised four presidents. We asked why Obama has been ahead for much of the campaign despite the weak economy (in large partbecause he avoided drawing challengers during the primary), howRomney as President would deal with the conservative HouseRepublicans (it may actually be the other way around, with power exercised from the House rather than from the White House in aRomney administration), and what the likely focus of foreign policymight be in a second term for Obama (he would prefer to focus onChina, but it would be difficult for him to divert attention from theMiddle East and especially Iran), among other key questions aboutthe election and the (somewhat sorry) state of US politics.

We also lay out the key dates and likely paths to resolution of thefiscal cliff the most important and most imminent challenge thatthe elected candidate will be forced to face just after the election

(page 5) as well as a handy summary of where the candidatesstand on key economic issues (page 7).

We then look at asset implications of US elections. In Electioncycles and assets Jose Ursua (with contributions from Silvia

Ardagna, George Cole and Thomas Stolper) looks at theperformance of assets within the four-year US election cycle andfinds that equity markets tend to underperform noticeably in the firsthalf of the cycle relative to the second half, a pattern that is echoedin equity markets abroad. This pattern is the opposite of whatoccurs in rates, suggesting an asset rotation story may in playaround election cycles. Stuart Kaiser then takes a closer look at thesensitivity of equity market returns to election outcomes, findingthat the S&P500 doesnt care about what party is in the WhiteHouse, but certain sectors do. Our snapshot table on page 6summarizes all of our views on election impacts across assets, withimpacts clearest for equities, but many assets vulnerable to thelooming fiscal cliff, which the election outcome will certainly havebearing on.

For those readers less familiar with the US political process, wealso include a guide to the US electoral process on page 12.

Allison Nathan, Editor Email: [email protected]: +212-357-7504Goldman, Sachs & Co

Key dates

Source: Goldman Sachs Global ECS Research.

Mar 2013

Nov 6, 2012US Presidential andCongressional elections

Dec 31, 2012Fiscal cliff takes effect

Jan 2, 2013Sequester takes effect

Jan 3, 2013New Congresstakes office

Jan 20, 2013Presidentialinauguration

Late Feb/early Mar Debt limit likelyreached

Nov 12 year endLame duck period for Congress begins

Dec2012

Nov2012

Oct2012

Feb2013

Jan2013

Oct 22, 20123 rd Presidential debate(Boca Raton, FL)

Oct 26, 2012US 3Q GDPrelease

Nov 2, 2012Oct job report(unemployment,payrolls)

Late Nov/early DecDebt ceiling likelyform ally reachedalthough measurescan likely extendfinancing capacityuntil Mar 2013

Nov 26, 2012Fiscal cliff debate likelyto begin in earnest

Dec 15-21, 2012Most likely period for a (short-term) resolution of the Fiscal clif f

ELECTION

FISCAL CLIFF

US Election Inspection


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Top of Mind Issue 5

Alec Phillips our Washington DC politicalexpert explains why this election isexceptionally important to the economy

The 2012 US presidential election is perhaps one of the mostunique and important elections in recent history from aneconomic perspective. In choosing its leader for the next four years, the country will likely be determining the path for near-termeconomic growth, medium-to-longer term fiscal stability andmonetary policy at a time when the stakes are exceptionallyhigh whether or not the US economy returns to recessionaryconditions in 2013, the US sovereign debt rating and the broader credibility of the US government to Americans and foreigners alikeall hang in the balance. There are three factors that set the 2012election apart:

Legislative inaction now a greater risk than legislative action

The potential for legislative inaction may pose a greater riskand more uncertainty than legislative action , suggesting thatthe one almost foregone outcome of the currentelection divided government poses greater challenges thanin the past. Typically, divided government is viewed as aconstructive political outcome by markets as it (normally) reducesthe likelihood of major policy change and hence policy uncertainty.But in the current environment the opposite may be true, asCongress must take action (by year-end in many instances) toavoid large (and mostly undesired) shifts in policy. This is becausepolicy has become more temporary, mainly owing to thecongressional budget process, which measures the cost of legislation over ten years and thus makes temporary legislation

appear less expensive than longer-lasting policies.The glaring risk in front of Congress is the fiscal cliff roughly3.5% of GDP in tax increases and spending cuts set to occur atyear-end. This makes the 2012 election one of only a fewcontests in which such a large fiscal policy shift was on thetable so soon after the election took place (2008 is arguablyanother example, when the election represented, in part, areferendum on the size and composition of a stimulus packageexpected to be passed early in the following year). Our base caseis that Congress will just barely reach an agreement before the endof the year, averting most of this fiscal restraint, but it is quitepossible that Congress could fail to address the issue by thatdeadline, leading to a substantial fiscal drag on growth, at leasttemporarily.

A status quo political outcome raises the risk of a game of fiscalchicken at year end, in which policy goes off the cliff unless oneparty reverses their long-held position on the upper income portionof the 2001/2003 tax cut (luckily for the US economyand unlikethe real game of chickena retroactive extension is possible inearly 2013). A Romney win seems more likely to lead to a short-term extension of the 2001/2003 tax cuts and some aspects of thefiscal cliff. In either scenario, it is imperative that Congress act,which is a unique and important difference from typical elections,with the economic consequences of them failing to do so potentiallyrecessionary.

The fiscal stakes are higher than they have been in decades

Beyond the fiscal cliff, the winner in November will face a potentiallyfrustrating fiscal landscape: on one hand, the elevated level of

debtaround 75% of GDP and risinglimits the fiscal room tomaneuver. On the other hand, the Treasurys exceptionally cheapinterest expensearound 1.4% of GDP, less than half the level thatprompted deficit reduction efforts in the late 1980s and 1990shasdulled the pressure on lawmakers to tackle these issues. Thisshould be a recipe for inaction. But two issues will likely raise thestakes in reaching a longer-term fiscal agreement early on inthe next administration: (1) the need to once again increase thedebt ceiling which congressional Republicans would like to matchwith deficit reduction (over ten years) of an equal amount, and (2)the renewed threat of a sovereign downgrade by the ratingsagencies, who have signaled as much if the US doesnt stabilize itsdebt ratio by mid-decade. A deficit reduction agreement of $2 trillionover ten years could resolve both issues, but with the easy cutsalready made in last years debt limit agreement, only the mostdifficult aspects of a fiscal grand bargain remain.

Monetary policy in (political) focus

Elected officials have hardly been indifferent to monetary policy in

the past, but there have been few elections where Fed policywas as widely debated as it is today . Compounding this is theexpiration of Chairman Bernankes term in January 2014; Romneyhas already indicated that he will not nominate Chairman Bernankefor another term. While Romney is not alone in making hisintentions to replace the chairman clear, what makes this situationunique is that it comes at a time when the Fed is pursuingunconventional policy that depends much more than usual on aforward commitment that occurs mostly past the end of the currentChairmans tenure.

Monetary policy becoming more political Fed Chairman Senate confirmation votes, % Senators voting

Source: Library of Congress, Associated Press.

Any of these issues would make the upcoming election animportant one for the economic outlook, but the combination of anear-term risk in the fiscal cliff, increasingly problematic medium-term fiscal dynamics, and election-driven uncertainty on monetarypolicy at a time when the credibility of future commitments isnecessary for its success make this a unique election, withpotentially substantial and far-reaching economic impacts.

Alec Phillips, US Political EconomistEmail: [email protected] Goldman, Sachs & Co.Tel: 202-637-3746

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60 votes needed to overcome filibuster

* Unanimous c onsent or voice vote (i.e., no roll call vote held)

The morepoliticized,

the lessvoters

Why this election matters more than most


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Top of Mind Issue 5


US ElectionNovember 6

Romney winsObama wins

D HouseD Senate

80%chance of no c liff

Status quoR House

D Senate


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OBAMA ROMNEY

Economy

Stimulative policies to grow the economy in the shortterm. Cut spending and raise taxes on wealthy to

reduce the deficit in the long term.

Cut spending to reduce the size of the government andreturn more power to the states. Cut taxes/keep taxes

low to motivate more household/corporate spending toboost the economy.

Fiscal Policy

Cut projected deficits by $4trn over 10 years through acombination of spending cuts and tax increases,primarily on the wealthy.

Cut unspecified federal spending by $500bn/yr by2016 and cap it at 20% of GDP (as opposed to 23.5%now).Institute a Balanced Budget Amendment to the USConstitution.

Tax Policy

Extend Bush-era tax cuts for everyone making under $200k, or $250k for couples.Ensure taxpayers with over $1mn income pay at leasta 30% tax rate.Increase the top two tax rates back up 3 to 4 points to39.6% and 36%.Limit tax preferences for upper incomes.Raise rates on capital gains (to 20%) and dividendstaxes for earners over $250k.Lower top corporate tax rate to 28%; give tax breaks toUS manufacturers.Maintain worldwide tax system.

Extend Bush tax cuts for all people; make permanent,across-the-board 20% cut in marginal rates. Lower highest tax rate to 28%.Limit or eliminate tax preferences to offset budgetaryeffects of rate reductions.Maintain current tax rates on dividends and capitalgains.Eliminate capital gains, dividends, and interest taxesfor any taxpayer with adjusted gross income under $200k.Eliminate the estate tax.Repeal the Alternative Minimum Tax (AMT).Lower the corporate income tax rate to 25%.Transition to a territorial tax system (income is taxedonly in countries where it is earned; in the current USworldwide tax system income is taxed at the US rateregardless of whether the income is earned within USborders or overseas.)

Regulatory Policy

Continue to uphold and support the Affordable Care Act and Dodd-Frank.

Repeal the Affordable Care Act.Repeal and replace Dodd-Frank.Cap new regulatory costs at zero dollars.

Require Congress to approve all major regulations.Reform legal liability system.Amend Sarbanes-Oxley to reduce the burden on smallfirms.

Where they stand


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Top of Mind Issue 5

David Gergen serves as a senior political analyst for CNN and is a professor of public service anddirector of the Center for Public Leadership at the Harvard Kennedy School. He has served as aWhite House adviser to four US presidents: Nixon, Ford, Reagan and Clinton, and is a NY Times

best-selling author on these experiences. Below he shares his insights on the upcoming USelections, the state of US politics today, and where theyre potentially headed in the future.The views stated herein are those of the interviewee and do not necessarily reflect those of Goldman Sachs.

Allison Nathan: What are the keyissues of this presidential election?

David Gergen: The creation of jobs andtaming of the deficits by far and awayare the most important issues in thecampaign. But it should be understoodthat for certain voters who are key to theoutcome there are additional issues.Women, for example, care deeply aboutabortion and pay equity. Latinos caredeeply about immigration. Both groupscould swing the election.

Allison Nathan: Why has Obama been mostly ahead in thepolls despite such a weak economy and high unemployment?

David Gergen: That's been one of the biggest mysteries of thecampaign. For a full year, from October 2011 to October 2012, thePresident was ahead. I think that's mostly because of two factors.One is that his team effectively discouraged anyone fromrunning against him in the Democratic primaries. In tenelections since World War II, an incumbent president has sought anew term. The only three presidents who lost were men who drew aprimary challenger: Ford, Carter and Bush Senior. Obamasquelched that early. The other factor is that the Obama team ismore experienced and was able to get the jump on the Romneyteam last summer with advertising and organization, remaining onestep ahead until the first debate.

Allison Nathan: Are there unique challenges that a Presidentfaces in a second term?

David Gergen: Historically, second term Presidents have facedtwo problems. First, there tends to be a sense of arrogance thatcan dull the political capacity of any team. Secondly, second termPresidents tend to be weaker at home than in the first term.Typically, a president has about a year in his second term when

he's strong and people look to him to exercise authority, but after the end of that year power just sort of seeps out of the WhiteHouse. People start looking over the Presidents shoulder to themid-term elections where the incumbent party often loses badly,and attention also turns to the next presidential election.

Allison Nathan: Would Obama approach foreign policydifferently in a second term?

David Gergen: Because presidential power declines so rapidly athome over the course of a second term, the White House tends topay much more attention to foreign affairs. This President hasmade it clear that he wants to "pivot" his focus toward the Far East and to China in particular, and away from the Middle Eastwhere much of his focus has been aimed during his first term. But

it's going to be impossible for him to turn away completely from theMiddle East where there's so much turmoil. The greatest near-termthreat one that could have enormous consequences for whoever is elected is the growing possibility that the escalating conflict withIran could come to a boil in 2013.

Allison Nathan: Would Obama use a second term to pursueanother big deal?

David Gergen: Yes, I think he's extremely likely to pursue agrand bargain on fiscal issues. I imagine the starting pointwould be the negotiations that he and John Boehner (R-OH;Speaker of the House) were engaged in around the debt limitdebate in 2011 that fell apart. That will raise two major questions:will House Republicans agree to increase revenue by at least$800bn over 10 years, an idea that Boehner was entertaining? Andsecond, will Democrats be willing to tolerate social spending cutsand serious structural changes in Medicare and other entitlementsthat Republicans will insist upon as the price of a deal? We don'tknow the answer to either question. Please note that as part of revenue raising, Obama wants to decouple income tax rates sothat the Bush tax cuts would be extended for every couple earningbelow $250k in income, while the rates would go up for peopleearning above $250k. Republicans have strongly opposed that inthe past. If Obama wins there is a possible compromise that wouldentail decoupling for people with annual income above $1mn.

Allison Nathan: It is widely known that Treasury SecretaryGeithner would not stay on for a second Obama term. How

might a new Treasury Secretary approach the role differently?David Gergen: The focus of the next treasury secretary isexpected to be more on domestic affairs than international, andtrying to negotiate a grand bargain that gets the deficit under control and the US economy back on track. One person oftenmentioned in terms of succession is Jack Lew , the current Chief of Staff at the White House and previous budget chief. Generally,the indications are that a second Obama term would bring a gameof musical chairs, with the people who are already there switchingplaces and fewer outsiders coming in. The inside wisdom aboutsuccession is that it's no longer possible for any Wall Street figureto be confirmed. The one exception from the financial communitywho is often mentioned as a possible nominee is Larry Fink.

Allison Nathan: How has Romney managed to improve hischances so much, so quickly?

David Gergen: The first debate was a defining moment for Romney and for the election. It is now apparent that there weremany voters who were open to a Romney candidacy early on butwere possibly turned off by what they perceived as the extremismof the Republican Party or by a very effective negative advertisingcampaign by the Democrats. Whatever the reasons, the Romneywho showed up at the first debate was a compelling figure andbrought a lot of the soft voters who were tilting toward Obama backto the Republican camp. And so we've gone from what looked like asure Obama victory and maybe even a landslide to a horseracethat Romney could win.

Allison Nathan: What would be the focus of a Romneyadministration?

David Gergen: There's no question that Romney's focus would beon the creation of jobs and the taming of the deficit. His grandbargain would clearly have much less emphasis on raising

Interview with David Gergen


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Top of Mind Issue 5

revenue (through taxes) and much more emphasis on cuttingspending and structural reform of entitlements. But whether hecould sustain that in the Senate is the harder question. Its verylikely that the Senate will remain Democratic so there's a bigquestion about whether he, like Obama, will find that Washington isparalyzed and it will be very difficult to get things done.

Allison Nathan: Beyond obstacles in the Senate, how wouldRomney deal with conservative House Republicans?

David Gergen: If this had been a landslide for Obama andDemocrats had gained a number of seats in the House, that mighthave sent a ripple of fear through the House Republican and theymight have been more willing to compromise. But if it's very closeand they maintain their majority the incentives for compromise arediminished sharply. There are hard line conservatives who haveargued that in a Romney administration power should beexercised from the House rather than from the White House. The House would create the legislative packages, negotiate withthe Senate, and then send the resulting legislation to the White

House to be signed as opposed to the Presidents agenda servingas the centerpiece of negotiations. I think that's possible. Much of the intellectual creativity in the Republican Party is centered in theHouse and people like Paul Ryan. Ryan is going to be a pivotalplayer whether or not Romney wins. Hes either going to be achief negotiator for Romney should he get elected. Or he's going tobe a chief negotiator in the House in an Obama second term.

Allison Nathan: Is there a chance that the balance of power inthe House and/or Senate shifts?

David Gergen: Had President Obama broken this open there wasa real possibility that his coattails could have brought a larger number of Democrats into the Senate. Because it now looks like amuch closer election, the likelihood is that the changes in theSenate will be fairly modest, with Democrats maintaining a smallmajority. On the other hand, its unlikely that the Republicans gain amajority in the Senate at this point. The best indications are alsothat changes in the House will be modest. Bottom line, if President Obama is reelected, it could well be a status quoelection. And if Romney is elected, he will very likely have thebenefit of a Republican-dominated House, but have to contend witha Democratic majority in the Senate.

Allison Nathan: Will the election affect the fiscal cliff outcome?

David Gergen: Its striking to me how many insiders are growingoptimistic that we will not only avoid the cliff, but reach a grandbargain this year. My bet is that no matter who gets elected wewon't go over the cliff. The Congress and the White House will finda way to postpone resolution of these issues until 2013. People inWashington can be seen as dumb but they're not crazy.

Allison Nathan: Will the election affect US monetary policy?

David Gergen: Yes, it clearly will affect who's running monetarypolicy given that Bernanke's term runs out in 2014. And MittRomney has promised that he will replace Bernanke. He said thatto please the Right, but it was one of those campaign events thathe may end up regretting. I was in the Reagan White House whenReagan came to office and Paul Volcker was the Fed Chairman,but appointed by Jimmy Carter. We went through a serious processinside about whether Volcker should be reappointed. PresidentReagan fortunately decided to reappoint him, but Reagan kept his

powder dry until he had a chance to really examine the issue.

Romneys commitment to removing Bernanke would make itmore difficult for the White House and the Fed to get along inthe interim in a Romney administration. I think the Fed will pursuethe same course its on as long as Bernanke is there, but it's goingto create uncertainty in the US and overseas about where Fedpolicy goes post Bernanke, and that's not a good thing.

Allison Nathan: What has driven the current polarization in DCand in the country as a whole?

David Gergen: There are a variety of factors that enter into it.Income inequality is clearly one of them. Redistricting (re-drawingelectoral district boundaries) has made a big difference. Thegrowing demographic gaps in the country are making a difference.

And increased extremism within the political parties has been afactor Democrats may have a point when they say that theinfluence of the Tea Party (a movement within the Republican Partythat aims to reduce government spending and taxes) has madeRepublicans more recalcitrant. But I believe that a large part of itowes to the media. Media on the one hand reflects what's going

on in the culture and on the other hand, drives it. The conversationin the media has become much rougher and more partisan. Socialmedia in particular has become a fierce battleground for partisansof both sides and has contributed to a now deep-seated culture of polarization, with Americans even increasingly moving to like-minded red or blue communities.

Allison Nathan: Do the President or members of Congressreally want to do bipartisan deals?

David Gergen: No. There are people on both sides who feelstrongly that there has already been too much compromise. Idisagree with that. Almost all of the major social milestonelegislation that has been passed since the 1930s has been enactedon a bipartisan basis. The civil rights bills of '64 and '65 would nothave been passed had it not been for spirited bipartisanship.

Allison Nathan: Is there any hope that the politicalenvironment could improve?

David Gergen: One of the great hopes for the future is that themillennial generation has the promise of being the bestgeneration since World War II. I see two streams of people whoare coming into politics and could transform politics over time. I'mon the Board for Teach for America, which recruits promising recentcollege graduates to teach in the roughest schools in the countryfor two years. The number of volunteers who are coming in fromschools all over the country is just unbelievable. Today, one out of every five Harvard seniors say they would prefer teaching theeighth grade in an urban school rather than going into investmentbanking. Also, the silver lining of twelve years of war is the youngpeople coming back, taking off their uniforms and pitching in toimprove life in our country. I have been very impressed with thisgroup of young individuals.

Allison Nathan: Any early views on 2016?

David Gergen: Incredibly enough we could have a Clinton/Bushelection! It would not be a surprise to see Hillary Clinton on theDemocratic ticket. On the Republican side, should Romney lose,well have to wait and see how the party shakes out. But clearlymoderate Republicans would love to see Jeb Bush jump in therace. Paul Ryan is also going to come out of this campaign as amajor contender in 2016 if the Romney/Ryan ticket goes down.


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Top of Mind Issue 5

Jose Ursua of our Global economics teamreviews patterns in equities (and other assets) around election cycles/the Big Day

The 2012-2013 election season is exceptional, with more than 100elections in economies accounting for approximately 60% of globalGDP. So far, markets have navigated through elections in Russia,Egypt, Greece, France, Mexico and Venezuela, among others. Theclosely watched Presidential election in the US will take placeshortly, followed by the culmination of the political transition inChina. Later on, markets will see countries like Italy, Iran, andJapan go to the ballots too. This extraordinary election seasonbrings several questions to the forefront: Why are electionsimportant market events? How do equities reflect the US electoralcycle? And does it affect markets abroad, and other assets?

Why elections matter

There are at least three reasons why elections matter for markets.First, the political stakes in elections often translate into policychanges that reshape the economic environment. Second, theregularity with which elections take place may lead to cyclicalpatterns in government and investment behavior. Third, electionscan markedly increase uncertainty. These factors can affect allasset classes, especially equities because of their strong sensitivityto changes in the economic outlook.

Election cycles and equities: Bad news for the first 2 years

The US Presidential election cycle matters for equity returns, athome and abroad. US Presidential election cycles (four-year cycles that always start between the second and eighth of November) since 1928, have tended to produce considerablylower US equity price returns in the first two years of the four-year cycle than in the last two (with historical averages around3%-4% vs. 10%-12%). This is true even when attempting toaccount for other seasonal, market and economic factors.Considering those other factors, returns during the first and secondyears are only a quarter and a sixth of those in the third year. Thesecond year in the cycle also tends to show the highest volatility (byaround 150bp-200bp). Those patterns also travel abroad. Thedata are not as good outside of the US, but nevertheless also showthat US election cycles are important drivers of equity returns inother developed and emerging markets alike.

DID YOU KNOW?

Over the past 30 years, the frequency of elections hasdramatically increased in EMs. While the average frequencyremains 1 per month in DMs, it has increased from about 2 to 4in EMs. It is now common for there to be around 55 electionsper year around the world.

Why do equities follow this pattern? Promising explanations fromvarious studies touch on the role of political business cycles(expansive policies in the later part of the cycle, which could leakout to other countries), market sentiment (expressions of earlydisappointment followed by second-half optimism), and behavioralpatterns on the side of investors (rules of thumb or myopia).

The Big Day increases equity volatility

Beyond the four-year cycle, elections have an impact on equitymarkets during the surrounding months of the Election Day itself. Inthe run-up to US elections, returns tend to move sideways as areflection of unresolved uncertainty. Later on, as the unknowns are

resolved, returns gradually bounce back. There also tends to be ablip in volatility immediately following elections, which may reflectconcerns on policy changes, close-calls, or surprises.

Bad (equity) news for the next two years?

Yearly S&P 500 average price returns from election year to the nextsince 1928 in % (lhs); Returns standard deviation in % (rhs)

Source: Haver Analytics, Goldman Sachs Global ECS Research.

Less stark and more mixed for rates and FX

The impact of the US Presidential election on other assets is lessstark in some cases, and altogether less clear in others. In fixedincome markets over the four years of the presidential cycle, totalreturns from investing in an index of 10-year US government bondson average peak in the second year after an election and decreasein the third and four years. This pattern is the opposite of what isobserved in the equity markets , suggesting that investors maychange their asset allocation from bonds to equities in the secondhalf of the mandate. The pattern is similar for shorter maturities,including 2- and 5-year Treasuries. However, the difference inreturns between each of the years is only moderate. In contrast toequities, there is very little evidence that uncertainty aroundelections impacts bond returns. Looking at average volatility of returns over a 6-month window centered on presidential elections,there is no significant impact on volatility before elections, and onlya slight increase in the months afterwards.

For FX, there is substantial focus on election impacts, given severalexamples of large Dollar moves surrounding elections over the lasttwo decades: a 5% appreciation of the Dollar on a trade-weightedbasis in the 6 weeks surrounding the election of President Clintonin 1992, a 4% depreciation surrounding the re-election of President

G.W. Bush in 2004, and a 7% appreciation surrounding the 2008election of President Obama. But, on closer inspection, all of thesemoves had unique drivers apart from the election: the ExchangeRate Mechanism (ERM) crisis in September 1992 (when the UKwas forced to give up its attempt to adopt the euro, with UK Sterlingdepreciating by 11% against the Dollar, and the Italian Liradepreciating by 7%), a broader Dollar-down trend that began in2002, largely caused by a worsening BBoP, rising public debt andweak economic growth, and increased risk aversion post theLehman bankruptcy in 2008, which tends to be Dollar positive. Onnet, its tough to make the case that elections have had anymeaningful impact on the Dollar in the past.

Jose Ursua, Global EconomistEmail: [email protected] Goldman, Sachs & Co.Tel: 212-357-2234

A special thanks to Silvia Ardagna/George Cole and ThomasStolper for their contributions on rates and FX.

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Election cycles and assets


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Stuart Kaiser of our US Portfolio Strategyteam discusses the insignificance of politicalparties to US equity index returns, but

significance to sector returnsThe interaction of equity performance and political outcomes hasgarnered significant attention over the past four years thanks to acharged political environment and important regulatory actions,particularly in the Financials and Health Care sectors. Still, thehistorical relationship between equity returns and which partycontrols the White House has been loose. In contrast, sector performance reveals some divergence across party lines.

Index indifference: Its the economy, stupid

Since the mid-1970s, equity markets have proven indifferent topolitical outcomes with median total returns all but identical whether the White House is Republican or Democrat. It has been theeconomy rather than investors responses to partisan changesthat has ultimately driven stock market performance over themedium term. For the past 40 years, S&P 500 median total returnshave risen roughly 10% in the twelve months following apresidential election, regardless of which party wins. Performanceis also very similar over shorter three- and six-month windows.However, returns are slightly better early in Republicanadministrations, while during an entire four-year term the equitymarket has somewhat higher median returns under Democrats. Wefocus on the more recent past (Jose Ursua instead looks at thehistory since 1928) so that results are comparable to the sector analysis below (where reliable data start in 1976), recognizing thatour sample size is inherently limited.

Index: No preference for parties S&P 500 median total return (%, not annualized) following Election Day,1976-present

Source: FactSet, Goldman Sachs Global ECS Research.

Parties matter for sectors

At the sector level politics and possibly policies appear to matter more. Over the past 35 years, Democratic terms have beenassociated with the outperformance of cyclical stocks while moredefensive and higher yielding sectors have outperformed duringRepublican administrations. In the near term, one year after aRepublican president is elected, Consumer Staples, Health Careand Financials have generally outperformed the S&P 500 whileMaterials and Tech have lagged. Conversely, following Democraticvictories, Information Technology and Telecom stocks have led themarket while Materials and Health Care have fallen off the pace.The past four years have largely followed suit with Consumer

Discretionary and Information Technology shares outperforming themarket since Election Day 2008. Meanwhile, Financials, Energy,and Utilities stocks have lagged the market, with all three impactedby regulatory issues to varying degrees. In contrast, Health Carehas outperformed the S&P 500 by about 550 bp.

Sector: Party preferencesTotal return relative to S&P 500, presidential admin. (1976-present)

Source: FactSet, Goldman Sachs Global ECS Research.

The current election: Energy, Financials, and Health Care

Looking ahead, the areas of the market most likely impacted bythe elections outcome are Energy, Financials, and Health Care given continued uncertainty over policy implementation. Historically,regulatory battlegrounds such as the Tobacco, Diversified andSpecialty Chemicals, and Pharma subsectors have outperformedimmediately following Republican victories. Within Energy,Integrated Oil & Gas and Refiners have outperformed after Democratic victories, while Exploration & Production andEquipment & Services prospered following Republican wins.

INVESTMENT TAXES IN FOCUS In our August 8th edition of Top of Mind, we discussed theimpact of a potential increase in the dividend tax rate. Under current law, long-term capital gains taxes are also set toincrease to 23.8% from the current maximum rate of 15%. If realized, this would be the largest single year increase in thetop rate in modern history. Despite that context, the maximumrate would remain below the 28-29% range in place from 1987-1996, and only slightly above the 21% rate from 1997-2002. Inaddition, the planned 2013 level is below (or on par with) capitalgains rates during 1934-1980.No matter who wins the election, capital gains taxes are likely torise for upper income investors. Obama supports such anincrease, contending that the 15% rate is anomalously lowrelative to history. While investors believe that Romney is morelikely to defend lower top rates, he has placed greater emphasison eliminating capital gains taxes for those making $200k or less as part of broader tax reform.The markets response to previous increases was not definitive.The S&P 500 traded down 7% during the month after a 9.0point increase from 1970-1972 was signed into law but rose 4%after an 8.0 point increase in 1987. More generally, there is nocorrelation between increases or decreases in the top rate andone month returns. This is somewhat intuitive: studies suggestthat roughly half of all capital gains accrue to individuals in thetop 0.1% of the US income distribution who may be lesssensitive to tax rates while tax rate cuts are not associated witha deadline to act.

Stuart Kaiser, Senior US Portfolio StrategistEmail: [email protected] Goldman, Sachs & Co.Tel: 212-357-6308

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+3m +6m +12m 4-year Repub lican Democrat

Sector (median return) Democrat Republican DifferenceInfo Tech 52.2 pp (35.7)pp 87.9 ppIndustrials 8.1 (2.1) 10.2Energy (11.4) (13.6) 2.3Health Care 9.2 9.4 (0.3)Financials (6.7) (2.9) (3.8)Telecom (17.1) 12.4 (29.5)Utilities (19.5) 11.8 (31.3)Materials (25.5) 10.7 (36.2)Consumer Discretionary (31.1) 6.9 (37.9)Consumer Staples (28.2) 65.3 (93.5)

S&P 500 Absolute Return 72.9 % 62.6 % 10.4 %

Do election outcomes matter to equities?


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Top of Mind Issue 5

US election process explainedThe US presidential election is held every four years on the Tuesday after the first Monday in November. Voters donot, technically, participate in a direct election of the president. They choose electors, who are pledged to one or another candidate. This is known as the Electoral College. The Electoral College consists of 538 electors. A majorityof 270 electoral votes is required to elect the President.Each state has a certain number of electors to the college, based on the size of i ts population. Specifically, eachstates entitled allotment of electors equals the number of members in its Congressional delegation: one for eachmember in the House of Representatives plus one for each of its two Senators.In almost every state, the winner of the popular vote gets all the electoral college votes in that state. Because of thissystem, a candidate can take the White House without winning the popular vote. The exceptions to this are Maineand Nebraska, where the state winner receives two Electors and the winner of each congressional district receivesone Elector. The District of Columbia is allocated 3 electors and treated like a state for purposes of the ElectoralCollege.On the first Monday after the second Wednesday in December after the presidential election, the electors meet intheir respective states, where they cast their votes for President and Vice President on separate ballots. Each stateselectoral votes are counted in a joint session of Congress on the 6th of January in the year following the meeting of the electors. The Vice President, as President of the Senate, presides over the count and announces the results of the vote. The President-Elect takes the oath of office and is sworn in as President of the United States on January20th in the year following the Presidential election.If no Presidential candidate wins 270 or more electoral votes, the House of Representatives decides the Presidentialelection. The House would elect the President by majority vote, choosing from the three candidates who received thegreatest number of electoral votes. The vote would be taken by state, with each state having one vote. It would be upto the group of representatives from each state to decide among themselves how their state would cast its one andonly vote. Smaller states like Wyoming, Montana and Vermont, with only one representative would wield as muchpower as California or New York. The House would have until the 4th of March to select a president.

Source: National Archives and Records Administration (NARA), US Federal Register.

The votesUS electoral votes and presidential leanings


NH4

MA11

HI4

WA12

OR7

CA55

NV6

ID4

UT6

AZ11

MT3

WY3

CO9

NM5

TX38

ND3

SD3

NE5

KS6

OK7

MN10

IA6

MO10

AR6

LA8

WI10

IL20

IN11

KY8

TN11

MS6

AL9

GA16

SC9

FL29

NC15

VA13

WV5

OH18

PA20

NY29

ME

4

MI16

AK3

RI4

CT

7

NJ14

DE3

MD10

DC

3

VT3

Solid D

Lean D

Solid R

Lean R

Swing


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Top of Mind Issue 5

Economic confidence (surprisingly) highEconomic Confidence Index (30 day ma of 3-day survey period)

The horserace% (unless specified otherwise); shaded = tossup, as of Oct 23

Source: Gallup. Source: FiveThirtyEight, The New York Times, Nate Silver.

Employment matters, at least historicallyElection year unemployment rates in %

Location, location, location: employment higher in key states%

Source: Bureau of Labor Statistics, Larry Sabato (UVA). Source: Bureau of Labor Statistics, Goldman Sachs Global ECS Research.

Divided government = Tighter fiscal policy

Net federal savings as a % of GDP

Election affection

Global elections 2012-2013

Source: Goldman Sachs Global ECS Research, Congressional Budget Office. Source: CEPSS-Elect. Guide; World Bank; Goldman Sachs Global ECS Research.

-70

-60

-50

-40

-30

-20

-10

0 Oba ma Romne y Margin in favor of

Electoral vote 290.8 247.2 43.6 Obama

Popular vote 50.1% 48.8% 1% ObamaPoll Avg. 47.6% 46.6% 1.0% ObamaProj. Vote 49.6% 49.4% 0.2% ObamaPoll Avg. 47.0% 47.7% -0.7% -Proj. Vote 48.8% 50.4% 1.6% RomneyPoll Avg. 49.0% 46.2% 2.8% ObamaProj. Vote 50.4% 48.6% 1.8% ObamaPoll Avg. 49.1% 46.2% 2.9% ObamaProj. Vote 50.8% 48.4% 2.4% ObamaPoll Avg. 48.9% 45.4% 3.5% ObamaProj. Vote 50.7% 48.1% 2.6% ObamaPoll Avg. 48.2% 45.3% 2.9% ObamaProj. Vote 50.4% 48.3% 2.1% ObamaPoll Avg. 47.6% 46.9% 0.7% ObamaProj. Vote 49.7% 49.6% -0.1% RomneyPoll Avg. 49.8% 45.8% 4.0% ObamaProj. Vote 51.4% 47.9% 3.5% Obama

OH

VA

WI

CO

FL

IA

NH

NV

President Year November of Pre-election

Year

November of Election

Year

Result

Obama 2011-12 8.60% ??? ???

Ford 1975-76 8.30% 7.80% LOSTCarter 1979-80 5.90% 7.50% LOST

H.W. Bush 1991-92 7.00% 7.40% LOST

Reagan 1983-84 8.50% 7.20% WON

G.W. Bush 2003-04 5.60% 5.40% WON

Clinton 1995-96 5.80% 5.40% WON

Nixon 1971-72 6.00% 5.30% WON

Johnson 1963-64 5.70% 4.80% WON

Eisenhower 1955-56 4.20% 4.30% WON

Truman 1947-48 2.90% 3.80% WON

Only three of the eight battleground states, Nevada, Colorado, and Florida areabove the national average of 7.8%

Republican Governor Democratic Governor

12.1%unemployment

----------------------

1.1%since Nov.2010

8.2%unemployment

----------------------

0.3%since Nov.2010

CO

8.8%unemployment

----------------------

1.3%since Nov.2010

FL

5.7%unemployment

----------------------

0.4%since Nov.2010

NH

5.5%unemployment

----------------------

0.1%since Nov.2010

IAVA5.9%

unemployment----------------------

0.3%since Nov.2010

OH7.2%

unemployment----------------------

0.9%since Nov.2010

WI

7.5%unemployment

----------------------

0.4%since Nov.2010

-1.

-1.

-0.

0.0

0.5

1.0

1.5

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

-7 -6 -5 -4 -3 -2 -1 0 +1 +2 +3 +4 +5 +6 +7 +8

Split Control to Single Party Control ('76, '92, '00, '08)

Split Control Continued ('72, '84, '88, '96)

Cyclically adjusted net federal saving (change frompresidential election quarter):

Budget balanceimproves when

governmentremains divided

Budget balancedeteriorates

when a singleparty takes

control

Country Type DateShare of

World's GDP(PPP)*

GDP per capita(PPP)*

Russia Presidential 4-Mar 3.00 14,808

Slovakia Parliamentary 10-Mar 0.16 20,757

France Presid. (1 round) 22-Apr 2.78 29,819

Egypt President April 0.65 5,547

Greece Parliamentary April 0.36 22,558

France Legisl. (1 round) 10-Jun 2.78 29,819

Iceland Presidential 30-Jun 0.02 33,618

Mexico Pres. & Leg. 1-Jul 2.09 12,776

Austria Legislative Sep. 0.44 36,353

Hong Kong Legislative Sep. 0.44 43,844

Venezuela Presidential 7-Oct 0.47 11,258

U.S. Pres. & Leg. 6-Nov 18.87 42,486 South Korea Presidential Dec. 1.95 27,541

Czech Rep. Presidential Feb. 0.36 23,967 Italy Parliamentary Apr. 2.34 27,069

Iran Presidential June 1.09 10,462

Japan Parliamentary 30-Aug 5.59 30,660 Chile Presidential Dec. 0.38 15,272

* Figures through 2011, except Iran.

US Election in pics

Obama vs Romney 2012, Fiscal Cliff Timeline

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