null Episode 11: Trump, Biden, and Municipal Bonds
Double Take podcast

Episode 11: Trump, Biden, and Municipal Bonds

Elections 2020 Double Take podcast Audio Equity Fixed Income
September 2020
Episode 11: Trump, Biden, and Municipal Bonds

Mellon’s Jeff Burger and outside expert Professor Richard Sylla discuss the 2020 US presidential candidates and their potential impact on muni bonds and the market.

Rafe Lewis: Hello and welcome to Double Take, the Mellon podcast. I'm your cohost Rafe Lewis, director of investigative investment research here at Mellon.

Jack Encarnacao: And I'm your other cohost and investigative researcher Jack Encarnacao. On this edition of Double Take, the 2020 US federal elections and what they mean for investors. Now, I know, I know. You've been seeing news stories and podcasts about the elections ad nauseum, but this one's different because we're taking on the quadrennial fund by looking backwards and forwards.

Rafe: That's right, Jack, and we're delighted to have Mellon's passionate and erudite Jeffrey Burger here to explain how all the electoral fun will impact fixed income investors, specifically those of you who park your money in the municipal bond markets.

Jack: But wait, there's more. I always wanted to say that. Wish we could, I don't know, give our listeners a set of steak knives or something, but it's not to be. We will also have a good long chat today with Richard Sylla from New York University, who is, I think it's safe to say, America's preeminent markets historian, and he'll discuss how previous elections have played out in the equity and fixed income markets and what those lessons portend for all of us in 2020 and beyond.

Rafe: Quick note, before we start here. I just want to remind folks that we are coming to you from our home offices, so please excuse any dog barks, cat meows, kids' screams, doorbells, et cetera. So, let's dive right in. So, Jeff Burger, let's give a little background. So, I had the pleasure of moderating an event for Mellon's interns recently that featured Jeff, and what struck me is that this is a fellow who really knows his way around a muni bond. And I'm talking specifically why they're floated, how they're floated, everything about demand and supply for them. You name it. This is someone who is steeped in this, and I think it's because he spent most of his life thinking about the public sector, what drives it, how it's funded, how politics impacts it. He did his undergraduate and graduate studies at Syracuse University and ultimately, obtained his master of public administration.

Rafe: And he was contemplating a career in the public sector before he ultimately ended up making a career out of trading on the loans that they need to make their sectors work. But since then, he's worked at Fitch Ratings, Columbia Management, and for the last decade or so, here at Mellon. Jeff, welcome.

Jeff Burger: Thank you. It's great to be here.

Rafe: Oh, it's great to have you. Much better for us than for you. So, why don't we just start big picture here for a second. What's at stake in these elections for muni bond investors? I mean, do the outcomes change dramatically, whether it's four more years of Donald Trump or for new years of Joe Biden?

Jeff: I appreciate the question, because it really gives an opportunity to what I would suggest and the team at Mellon would suggest is really the long standing background of this asset class to persevere through various, not only economic cycles, but political cycles. And it's not to suggest that there obviously are different implications for various markets, municipals included, depending on who is elected president come November, but the most likely outcomes under either presidency, whether it's infrastructure spent, the implications of tax policy, because taxes are very important when it comes to municipal bond investing. There's a case to be made under both presidencies that a favorable outcome to support this asset class in terms of potential return exists under both. And we can explore that too, if you would like.

Jack: Well, Jeff, I'd like to start, maybe if we could at the onset of the current administration and maybe that'll help us and our listeners understand kind of how to read political outcomes through a muni lens. So, Trump took office 2016. We ended up with a surge in buying, like almost 4 trillion in municipal bond market. Municipal bond market at about 4 trillion, a surge there, large inflows into mutual funds. They ended up calling it the Trump trade, I guess we could say.

Jeff: Yeah.

Jack: Could you take us through what's happened the past four years, if it met the market's expectations, and how we can game the outcome along political lines on the other side, perhaps?

Jeff: Absolutely. Well, this market does aim to please, and as you suggested earlier, the implications from Trump's presidency were pretty profound on the municipal bond market. And it gets back to one of the points I was driving at earlier, which is what do taxes mean, and how do they matter to municipal bond investors? And make no mistake, there's a lot of different reasons that Americans and even folks across shore now, because you're seeing a lot of foreign investment into this asset class, but really concentrating on Americans, specifically tax-paying Americans. One of the primary reasons they buy a municipal bond is the tax free nature of it. And when the tax cut and JOB Act was passed, I believe it was December of 2017 or so, effectively what it did and one of the rules in there as part of the law was it capped the amount of federal tax exemption from what Americans had already paid in state and local taxes.

Jeff: Well, think about that for a second. If you're somebody who lives in one of the affluent areas, let's just say, Westchester County, New York, or suburban San Francisco, what have you, who pays a heck of a lot more than $10,000 in state and local taxes? You're kind of frustrated. You're frustrated that you're not able to deduct that from your federal tax bill. And so, what a lot of investors across our country have done is looked for other ways to source shelter their taxable income. And guess what? One of the few standout investments that remains post the tax reform act that provides some tax advantage for American taxpayers are municipal bonds. And so, what we observed is really 61 straight weeks, over $120 billion of mutual fund inflows into this asset class. Truly unprecedented in terms of size and scope. And we would suggest one of the reasons you saw such demand from retail investors in the country was because of the tax cut and JOB Act.

Jeff: Again, that's associated with what Trump was got through in Congress in terms of tax policy changes. And I would say this. There's another implication of the presidency that likely impacted our market. President Trump ran, as part of his campaign, on an infrastructure program in the country. And to the extent that infrastructure is really funded in the United States, by municipal bonds, it really generated greater market awareness, greater interest in the asset class, et cetera. Now, clearly, the infrastructure program hasn't manifested itself for a plethora of reasons, but all that being said, the type of attention paid to municipal bonds and the need for infrastructure in this country have, from a thematic perspective, some residency in the marketplace, and we would argue additionally increased demand for municipal bonds.

Rafe: Jeff, I think president Obama would be the first to say that it's tough to get a lot of meaningful change done unless you have control of the Senate within your own party as well. So, I guess, how do you think about the upside and the downside risks to muni investors if control in the Senate changes hands, and now all of a sudden you have New York's Chuck Schumer as the majority leader?

Jeff: And again, it's always dangerous to sort of forecast outcomes, but the probability would suggest that if Schumer is the majority leader in the Senate, it's a very high likelihood that Biden is also president, right? I think we can pretty much agree to that. It'd be... Well, we don't really speak in binary saying there's no possibility, but if Schumer, if the Democrats win the Senate, it likely also means that retain the House and likely win the presidency. So, we're really talking under that context, I would argue. And under that context, what I would suggest is in terms of political implication, really from a policy perspective would be the following. It's pretty clear and transparent from what candidate Biden has proposed in terms of taxes. You notice I always come back to taxes as one of the reasons people consider municipal bonds.

Jeff: There's a higher profitability under a Democratic controlled Senate, House, and presidency that corporate tax rates would be upward adjusted. That from a municipal bond perspective would make the asset class more appealing to corporations and banks, because one of the reasons, like retail investors in the United States that they like this asset is the tax free nature of municipal bonds. When there was corporate tax reform to the downside as part of the tax cut and JOB Act, you saw a little less demand from corporations. And so, under the scenario you're really proposing, there probably would be a reversal of that, more demand. Now, counterbalancing that perhaps was really the support I mentioned earlier from the demand side of the equation of retail investors liking municipal bonds, because it's a reaction to the cap of $10,000 as the max you can deduct from your federal tax bill. Under let's just call it a blue wave, Senate, House, the presidency under Democrats, given that the $10,000 cap really disproportionately impacted blue states, I think there would be a lot of pressure on Democrats in Congress and the presidency to roll that back. And that on the margin might actually reduce demand for municipal bonds under that scenario.

Jeff: Now, one point I do want to stress though, it gets back to infrastructure. I think that, really, under both presidencies, a Trump or Biden election, there would be finally some push for infrastructure build in a meaningful way. And so, I would argue that is a positive for the asset class, but it's really a question of policy how that infrastructure program would be directed to really reflect the values of the parties in control. Another way of saying that is if it's a Democratic controlled Congress and presidency, the likelihood of more green projects, environmentally sensitive projects, some ways to provide some economic stimulus related to environmental and infrastructure spend would be part of their program.

Jeff: If Trump gets reelected, I believe that the pressure would be on the Democrats defined areas of agreement, as I think it's fair to say that the campaign right now to a certain extent is a referendum on Trump, and the leverage Democrats have to counterbalance that would be severely weakened if Trump gets reelected, suggesting that the American people have endorsed Trump for another four years. And I believe there would be incentives on the Democrats to find areas of agreement with President Trump. And one of the few areas that we can point to where they do have some agreement is on infrastructure. Now, the type of policies in terms of infrastructure build that would come out under Trump's administration would not likely be green focused per se, but they would still be infrastructure, just in other areas.

Jack: So, Jeff stepping back for a moment, this COVID-19 pandemic, the subsequent economic turmoil it's caused to really wrought havoc on a lot of state, county, and municipal budgets. I mean, funding sources like hotel and meals taxes, gone. Sales taxes reduced substantially. A lot of streams of revenue under duress right now. And on the one hand, that might mean that states, cities, towns, counties might have to borrow more money now than ever and thus, the municipal bond market is stimulated. On the other hand, they're probably a lot riskier to lend money to these days because of those uncertain income streams. So, how powerless is the state of public finances as you see it right now?

Jeff: So, I think all of your characterizations of this asset class, I would agree with, with the possible debate of the word a lot. And what we mean by that is it's a relative market. And so, when we suggest that risks have increased in municipal bond markets, I don't think that there's any dispute in that. I mean, you would have to be completely ignorant to the status of the world and the global economy right now not to have an opinion that relative credit risk has increased. That's absolutely true, and municipal governments are no different. However, one of the really interesting things about this market is its long standing history and some of the categorical differences between how municipal credit and governments operate versus corporations. First and foremost, this is a market that was established in 1812. And if you think about that, that might be somewhat recent in world history, but that is ancient in terms of the history of this country.

Jeff: And since 1812, we can all think about the different economic, political, you name it, wars, pandemics, et cetera, that this market has been through. And year after year after year, it basically comes out with a similar conclusion, and we're not taking that for granted per se. We're always contemplating new outcomes, but the historical precedence of outcomes in this asset class has been that municipal credit has been remarkably resilient under various economic scenarios. So, how does that manifest itself, really, in terms of the impact of coronavirus on the market? Well, we're of the opinion that while there might be some increase in defaults, particularly in the highest risk arenas of the market, whether that's continuing care retirement communities, nursing homes, et cetera, the lion's share of this asset class will continue to service its debt on time and when due. The biggest risk we see from a credit perspective really are more downgrades and spread widening.

Jeff: And ironically, given the inefficiencies in municipal bond markets, a very inefficient market in the grand scheme of things, ultimately it could be a great validation of active management because in certain extent, security selections could become more and more important, because you obviously want to buy bonds that are below their intrinsic value and hope that they accrete up to intrinsic value. And conversely, sell those that you think are overvalued. So, it's a valuation type market in our opinion. Now, we do separate credit risk from the economic impact of Corona 19, and it's clearly just a major challenge. Unfortunately, over a million public sector employees have already been laid off. It's clearly stressed the finances of local communities. Not to the extent where they're compromising debt service in general, but what likely is an outcome of this is if you are sending your child to public schools, the finances of public school systems, for example, might be more stressed. How does that manifest itself? It manifests itself in higher fees and charges for services. That means that that PTO fundraiser might be a little bit higher. Does it mean compromising of debt service? We don't think that's likely.

Rafe: But embedded in Jack's question, I guess, was also the assumption that issuances may go up as a result of their kind of fiscal strengths at the state, county, and local level. Is that an accurate assumption by us, or is that not really what you're banking on?

Jeff: Well, it's not even a matter of banking on. It's already happening, but there's a lot of nuance in that observation. So, if you look at your over year supply of municipal bonds, it's up. No doubt it's up. So, on the surface you would say, "Okay, there's a lot more supply." Just basic math, a lot of supply. Is there are enough demand to meet that supply? How does that impact prices? Well, first and foremost, demand is really strong again. There's a lot of demand for municipal bonds, not only from US investors, but as I suggested earlier, from non traditional buyers across the globe. But what's perhaps even more interesting is the composition of the supply of bonds that are coming to market. Now, I've talked a lot about the tax free nature of municipal bonds, and that is the lion's share of the asset class, but what we're observing right now is truly something that's unique.

Jeff: And what we're observing right now is a significant increase are what are known as taxable municipal securities. Think about this for a second. One of the reasons you've seen an increase in taxable securities is this. When an issuer, a government in the United States issue municipal bonds, it's a little bit more complex than what I'm about to describe, but essentially, the IRS tests what the use of proceeds are being used for. So, for example, in Boston, where we all live, the city of Boston is issuing debt for public schools. That is a project that the tax code wants to reduce the cost of capital. They want to make it cheaper for Boston, because public schools are good. If, for whatever reason Boston wanted to rebuild Fenway park or what have you, the test might say, "Great project. We love the Red Sox, et cetera, but we don't need to provide a market incentive of lower cost of capital."

Jeff: So, that's the taxable instrument. And it basically says that as an issuer, you have a lot more flexibility to do whatever you want with the use of proceeds if you issue a taxable security. So, long way of saying this. What you're seeing is a year over year increase in municipal supply, but it's coming in the form of taxable securities. In fact, if you look at the market composition right now, about 30 to 40% of the market this year is being issued in taxable form. Tax exempts are actually down about 8%. So, what does that mean? Well, it means a couple different things. One from a credit perspective, it's a good thing. Because again, if you're a issuer who doesn't know what the world is going to look like six months, a year from now, or what have you, come to market now. Issue those taxable securities. Have the freedom to do what you need to do with the use of proceeds, and lock in low rates.

Jeff: And so, you're seeing that. One of the reasons that, again, the longstanding history of this market has been so good from a credit perspective is issuers are actually more sophisticated than I think a lot of the public gives them credit for. The second is it's really feeding demand from those foreign investors. Foreign investors prefer a taxable instrument, all else equal, relative to a tax exempt. Why? Well, because of the higher yield. Because it's a taxable instrument for the US taxpayer. Now, think about this. If you're a foreign investor, you're agnostic to taxes. You don't pay US taxes if you live in Europe or in Asia, et cetera. They have tax free agreements to the US. All [inaudible 00:18:57] pay gross on municipal bond. And so, what they are really liking right now are these taxable instruments. They're not compromising credit quality, and they're getting relatively good yield. Now, issuers are responding to that demand and coming to market with that. So, it's a really good environment for issuers to come to market, because A, they can get access to capital to help preserve their finances over the medium term, and two, they're feeding a lot of demand in new classes of buyer. They're diversifying their investor base, and ultimately, over the long run, that's a good thing for them.

Jack: Jeff, if I could steer the conversation quickly back to a Biden outcome and a Trump outcome. Two things I want to ask you to read through those two possibilities, equal weighted. Not asking you to say which is more likely. Just a Trump world and a Biden world. One, infrastructure. You touched on that. Infrastructure has kind of been dangled for a long time as one area of bipartisan agreement. So, is infrastructure more likely if Trump wins or more likely if Biden wins? And second, those foreign investors in American municipal bonds. Which of the two outcomes do you think stimulates more activity from them, is more likely to stimulate more activity? Do they care who wins, or is the asset class equally attractive regardless of the outcome?

Jeff: Yeah. So, good questions all around there. In terms of the outcomes, I would say that likely just because of core philosophical principles of Democrats versus Republicans that have generally a higher bias towards government spending, I think that the higher likelihood would be on infrastructure under Biden. But as I suggested earlier, I do think that there would be incentives on both sides, even if Trump does win again, for infrastructure to be part of their platforms and they want to do. Again, I think there's market incentives and political incentives for both parties to have an infrastructure program. Now, clearly we have to look at this somewhat cynically, and I don't want to be Pollyanna-ish as someone who flies through... Or used to, I should say, fly through many of our airports that are in less than stellar condition and our roads and hospitals, and just a lot of need for infrastructure built our country, and we've been looking at it for years. So, you have to look at this from a somewhat cynical eye. You're almost making the argument, this time truly is different. Just say, "Okay, we're finally there. We're finally going to do that infrastructure program."

Jeff: But I do think a lot of the ingredients are in place under both potential presidencies. Again, infrastructure, if done correctly, can be highly stimulative to the economy. And two, from a political perspective, I do think that there is incentives on both sides to get it done. It's really a matter of what type of infrastructure and that's where the devil is in the details. Because again, infrastructure, if done correctly, we would argue can be highly stimulative to the economy. If it's not done correctly, it clearly could just be sunk cost and just kind of a waste of money.

Jeff: Now, to your second question about what do foreign investors really prefer? From my experience, I haven't really had much of that sort of feedback from overseas investors. I think they're... One of the most interesting things about the foreign investor is how new they are to this asset class. And it's really exciting to kind of... You don't want to say you're being evangelical about the asset class per se. Clearly, we have a lot of passion at Mellon about it, but at the same token, you're introducing a market that has been around for literally hundreds of years, to someone who hasn't heard much about it. And so, what we really try to do is de-emphasize the political nature of this asset class. Because again, if you look at the long standing history, it's been through various presidential parties. It's been through various economic regimes, and the long standing principle of it should stand up no matter who is president.

Jeff: I think it gets back to where we began this conversation, in terms of how a municipal bond is likely to perform or not perform under different economic policies, economic tax policies, to be very specific, and the general status of the US economy. So, there's a lot of arguments to be made that tax exempt municipals in particular tend to do relatively better when interest rates rise, because the value of that tax exempt nature of a municipal tax free security actually increases, because there's more demand for tax free savings with higher interest rates. And so, maybe an investor overseas might be asking themselves this question. Which president would have what impact on the economy, and how does that manifest itself into potential inflationary concerns? If you think one candidate or one presidency may lead to higher inflation due to whatever reason, higher economic output, et cetera, well, okay.

Jeff: Maybe you have an interest in a certain type of municipal bond, more of a bias towards a tax free instrument, which might do better. Or, if you think that we are in a regime where rates are going to be lower for longer, maybe you want to have a very long duration taxable, municipal bond portfolio that tends to do better under that scenario. So, the point is there's a lot of nuance to this. It's a lot more complicated than I think most people would think about on the surface. And we've been really impressed with the sophistication of our foreign investors, who after some study of what is a relatively new market, they get pretty excited and interested in all the different options they can make an employ in it.

Rafe: 32 flavors there, I guess. Well, your comments on politics and the bond markets, I think, are a great segue to what was my last question anyway, which is, you read again and again and again, and hear again and again and again, when you're watching the nightly news that the United States has never been more politically polarized than it is today. And I guess, maybe people are forgetting that there was a civil war fought here 150 years ago, but let's just stipulate to that assertion for a second. Polarization's never been like this before. So, what I wonder is does that political polarization extend to the muni markets? Do conservative investors shy away from bonds floated by liberal cities, or quote unquote sanctuary cities, and do progressive investors balk at red state munis, and that kind of thing? Has that happened?

Jeff: For the first time in my 22 year career, I actually just got that question from one of our investors the other day. So, the answer is, yes. I had not seen that. In the grand scheme of things, it's not at all prevalent, but because ultimately as a fiduciary and investors who are interested in making the best outcome for their portfolio, they try to separate politics from their investment strategy. And again, for the bulk of my career, really... The timing of your question is on the money. Two weeks ago, I got that question or suggestion. I won't say which state or city that the investor preferred, but it was clearly on political lines. And so, I have not seen that until recently, and it's interesting. Now, the follow up question to that is from a municipal sector perspective, do we have any sort of objective analysis internally saying that well, red states are run a certain way. Blue states are run a different way.

Jeff: I think that in general, it's tough to draw a very different conclusion. What we really do hammer on, though, is the credit aspects, regardless of the politics of the administration, either at the state or local level. We look at from an evaluation perspective, very key metrics in terms of leverage. We look at the economy. We look at the financial system, but most importantly, we look at management. And management, from our experience, will be the biggest indicator of the relative value of a municipal security. And in a very rare circumstance that a municipal bond has defaulted, whether it's a red area or a blue area, the one common denominator that we continuously see is poor management practices. You might have a terrible economy, but a great management system. You have a good chance of holding up.

Jeff: You might have a stellar economy, but a horrendous management system. All you got to do is look at Orange County, California in 1994. AAA economy, by no doubt. They had some fraud and poor management practices in their treasury department, and they went default. So, there really is a lot that goes into this. You're looking at a market of over 60,000 issuers. It's tough to draw and aggregate all the different nuances to one single statement. But again, as investors, we're dispassionate about the politics. We really look at management. But really, just to get back to your question in this polarized environment, first time of my career I saw that question. It's not to say that it's going to be the last time, and the probability of it happening again I guess is just higher, in terms of someone saying, "You know what? I don't want any red." "I don't want any blue," what have you. Very interesting.

Jack: So, sands shifting, but at the same time, as we head towards November, excitement on either side in terms of the outcome between Trump and Biden in the election. Jeff Burger reading it all for us here on Double Take through a municipal bond lens, of course. States, municipal bond holders, municipalities waiting to see what impact the legislation that might be generated by the winter here will have. Jeff, thanks so much for taking us through all this and helping us read the elections through a muni lens. It's been very interesting.

Jeff: My pleasure. I enjoyed this very much.

Rafe: Welcome back to our special elections episode here on Double Take, the Mellon Podcast. Joining us now, as promised, is Richard Sylla, Professor Emeritus of Economics at NYU's Stern School of Business. He has authored several books, including The American Capital Market and A History of Interest Rates. He has served as the President of the Economic History Association and the Business History Conference. And he's currently the chairman of the Museum of American Finance. Dick, welcome to Double Take.

Richard Sylla: Rafe, good to be with you this morning.

Jack: So Dick, we're in the weeks and days immediately prior to the federal elections here, which are, you could say, a referendum on President Trump and his populist message as much as anything else. Looking back at reelection campaigns such as this, professor, how well or how poorly you have the markets, I guess, priced in the eventual results of a presidential election? And what have the markets told you if anything, thus far in the election season about who might win and what ramifications we reasonably can expect on the economy?

Richard: Well, I think first thing to say is that 2020 is a bit of an odd year since we're having a pandemic and massive government interventions, both fiscal and monetary to ease the economic pain of the pandemic. And so this is an unusual year, and I would say that so far in the year, a lot of people are surprised by the strength of the stock market. And I don't think it has that much to do with the election. It has a lot to do with the fiscal and monetary stimulus and also the hopes that we will get a vaccine. So, as I'm looking at the markets in 2020, they haven't really reacted very much to the upcoming election or the campaign as it's taking place. And the campaign itself, of course, is odd because of the pandemic. We're not seeing a normal political campaign with rallies and speeches and stump speeches.

Richard: So I'd say it's an unusual year, but in perspective, the markets typically keep an eye on the elections. And I think that, in general, most elections don't represent a major change. You know, people say the two parties are Tweedledum and Tweedledee. But there are certain periods when the economy's in crisis, looking back, say, to FDR in 1932 at the pits of the depression. And 1968, the people are often saying that 1968, that was an election year, that that's a bit similar to this year in the sense that we had the political assassination, fortunately, we haven't had that this year, but we had riots in the streets and there was a lot of political turmoil. Most years are normal elections, the Democratic candidate and the Republican candidate don't seem all that different, but there are certain years like 1932 and 1968, where there is more of a polarization, I guess you would say, and more turmoil in the country. And the stock market sometimes reflects the electoral outcome.

Rafe: Looking back at those elections that you cited, back in '32 and in '68, those were a little different, I guess, because in '68 you did not have an incumbent running for reelection because Lyndon Baines Johnson pulled out, right?

Richard: That's right.

Rafe: But back in the thirties, that was an incumbent trying to get reelected, correct?

Richard: Herbert Hoover was running for reelection. And unfortunately he chose the worst year of the depression, 1932, to run for reelection. And the interesting thing about that year, the Dow Jones fell 89%, I think, from its peak at 1929. And it reached its low in July, 1932, and the low point of the Dow happened to occur right around the time the Democrats nominated Governor Franklin Roosevelt of New York to be their presidential candidate. And the markets went up after that. People were ready for a change, I think. And when it became clear that Governor Roosevelt was going to be the Democratic candidate, the markets bottomed out and started to rise. And even in the banking panic, after Roosevelt came into office, he had to shut down the nation's banks for a week or two in early 1933, the market didn't get back to that 1932 low, even though the country was still in major economic crisis. So I think that that election, somehow or other, the market sensed that a change in the form of Democrat Roosevelt being elected would be an improvement in the economy. And the market started going up from right around the time Roosevelt was nominated.

Jack: Professor, what about the dynamic here that has shaped up between President Trump, who, as some of our pre-show communication indicated, kind of a rarity in that he actually surprised the markets in winning the presidency. Often the markets aren't terribly surprised by who ultimately ends up winning in November. But we did have an exception in that regard in 2016 in several ways as Trump took office. Here he is against Joe Biden that you could characterize as a very strong contrast, hardly Tweedledee Tweedledum dynamics, as you talked about, where the market might say it's a relative toss up as to what we can reasonably read into the outcomes and they'll be about the same, regardless of which side of the aisle comes out on top.

Jack: Here, we have pretty strong, historical exceptions, it would seem to me, from a distance to that sort of analysis that the elections won't make that much of a difference. Plus, we have a president in Trump who through such a strong populous streak has really implemented some policies that have really had a lot of economic significance from tariffs, to our posture on the international stage, to how we manage and regulate foreign companies operating in the United States. Do you see here any parallels, this sort of unique alchemy between these two, or maybe it isn't so unique, that strikes you in the past?

Richard: Well, I think you're right that Joe Biden seems to be like a conventional candidate. He's been an American political figure for 40 to 50 years now as a Senator from Delaware and a vice president and under President Obama from 2009 to 2017. So I think he's a conventional American politician. And President Trump is obviously a very unconventional American politician. Going back to the election in 2016, I think that I, and many other people, sort of relied on the polls to say that Hillary Clinton went into the election with a lead and we thought she was going to win. And I'm told that even President Trump was a little surprised that he won that year. But it didn't seem to have a negative effect. I do remember that great gurus like Paul Krugman in The New York Times said if Trump is elected, the stock market would go into a deep dive. That did not happen. It actually rose a bit after Trump came in.

Richard: And I think people were surprised that he won and the markets, they didn't view unfavorably the fact that it was a surprise outcome in that election. And of course, one of the reasons I think, you didn't mention before, but one of the reasons was that Trump made a large corporate tax reduction in his first couple of years in office. And that was a great boost to the stock market. An interesting thing about President Trump is that he seems to rely on what the stock market's doing as an index of how well he's doing and the surprising bullishness of the market since after the crash in February and March, President Trump says that, "That shows that I'm really doing a great job, the fact that the stock market is doing so well." And he did a lot for the stock market, I think, with this corporate tax cut.

Jack: Does history tell us anything, professor, about after large tax cuts and positive market reaction to that, what tends to happen to the markets when the possibility might present itself, as it does with Biden, he's unveiled his tax plan, that some of those may be reversed? But there are all kinds of other offsetting reasons that you might think the market might be positive on a Biden presidency, less volatility, less concern about the day to day news cycle, does that offset that concern that those tax cuts might be reversed somehow or lessened?

Richard: Well, yes, I think that Biden has said almost that we can expect some higher taxes, although that in good Democrat fashion, he phrases it that it'll be mostly on the very well to do, not ordinary Americans. And so we can look forward to that. But I think the markets are also sensing that President Trump has had a foreign policy rattling the sword against China and with his tariffs and things like that. And I think business leaders, many business leaders anyway, that do a lot of business around the world, are kind of worried about Trump's foreign policy stance and so they may think that Biden will get us back to better relations with our trading partners and even countries that disagree with us on what the direction of world politics should be.

Richard: So I think maybe they're willing to say that Biden would be okay, even if he raises taxes on us, if he improves the international climate for trade, reverses some of Trump's tariffs, which are unpopular with many businesses, and the get tough with China policy, American business has done a lot of business in China and that seems to be threatened now. And so I think businesses are weighing the higher taxes against the more stable international economic environment. And so I don't think there's a strong business faction behind either candidate this year. They're just weighing the pluses and minuses of each one.

Rafe: Well, okay, so let's move away from the markets, I guess, to a certain extent, to the economy or other aspects of it, because everyone always says, "It's the economy, stupid." Right? That's the great cliche that came out of the '90s, but I am curious, we're in a super low interest rate environment right now. And you're the interest rate history guy, so I would ask, is there any correlation between interest rates and presidential elections? Do lower rates favor Republicans seeking reelection? Do they favor a Democrat combating a Republican seeking reelection? What can we read into this?

Richard: Well, there are certain elections where that makes a difference. For example, back when I was a young man, we had recessions in the 1950s and '60s. And if you think back to the election of 1960, that was John F. Kennedy versus Richard Nixon, and that happened to be a recession year. And the federal reserve, as many people say, often causes the recessions by reacting to inflationary fears by raising interest rates and that pushes the economy into a recession. And in the election of 1960, the economy was in recession and Richard Nixon, after he lost very narrowly to John F. Kennedy said that, "It was the rise in interest rates that caused the recession that caused me to lose the election to Kennedy." So, yes, I think interest rates can have an effect on elections.

Richard: And, of course, you mentioned the history of interest rates, I've seen a lot of range of interest rate history just in my adult lifetime, for example, in 1980/8, we had the highest interest rates US history and now we have the lowest interest rates in US history. And of course the election of 1980 was coming at a time when interest rates were very high. And that was when Paul Volcker was trying to break the back of the very strong inflation, even double digit inflation, by 1979 and '80 with very high interest rate policies. And that certainly didn't help Jimmy Carter. It helped Ronald Reagan win the election of 1980. So yes, the answer is that interest rates can have an effect on the economy and the election prospects of particular candidates.

Richard: This particular year, with very low interest rates, I think they're low for reasons that don't have much to do with... They're low in part because the economy has been in lockdown [inaudible 00:13:34], we saw the recent GDP statistics saying that at an annual rate the economy was collapsing around 30%. It actually collapsed about 9%, but if you take that 9% for the second quarter and run it out if it claps 9% for the next three quarters, it would be down 30 some percent for the year. So I think the economy's very weak right now, and that explains the low interest rates. In a normal environment, the low interest rates might help an incumbent. But in this particular environment, I don't see that the low interest rates are in any sense helping President Trump.

Rafe: Professor, the US standing in the world has certainly changed in the past four years, as have our alliances and relations generally. Thinking back to other periods, perhaps, when the US recoiled from international entanglements, what did that mean for investors? Have we had test cases of the moment we're in?

Richard: Well, I think the late 1930s when Hitler was rearming Germany, and of course, World War I actually started in 1939, we had a low interest rate environment then, and it was because of the whole 1930s were a depressed decade and so interest rates were low in the late '30s and the economy was a bit weak. There was a pretty good recovery under Roosevelt in his first term, but then we had a sharp recession in 1937, '38 that pushed unemployment back up to double digits. So going into World War II, we had a low interest rate environment. And I think the stock market wasn't doing a whole lot then. I mean, there was the international climate, the war breaking out in Europe. After Pearl Harbor, of course, at the end of 1941, we would get into the war, but there were people in the 1930s, America Firsters, Charles Lindbergh was one of them. And there were some radio people, Father Coughlin, in general, they were trying to keep the US out of international entanglements. And so there was a divide in the country then about what our policies should be.

Richard: And President Roosevelt had to manage that and I think he did a pretty good job of it. Actually, the war, to some extent, helped our economy because, the European countries that were going to war in the late 1930s, they place a lot orders in the US for materials, which helped our economic recovery. And of course, when we got into the war itself, then there was a strong economic recovery, but we also had wage and price controls. So the stock market didn't do a lot in World War II. And in fact, what I always told my students who think stocks always go up, the peak in 1929, the Dow Jones peak in September, 1929 was not reached again until 1954, a quarter century later. And in our own lifetime, we see that the Japanese stock market peaked out at 1989, and now it's 31 years later and it hasn't gotten back to that old peak. So the war was good for the American economy, but it wasn't so great for the US stock market, which just marked time in World War II, But then it boomed after the war.

Rafe: Professor, do you study the commodities markets much or is it mainly just a little bit?

Richard: Some.

Rafe: Because I am wondering what those markets are telling us as we're leading into this election as well.

Richard: The commodities that I keep an eye on regularly are precious metals. And gold has recently set up a new all time high at over $2,000 an ounce. And in August, the silver market is moving up rather sharply too. And I interpret that as a sign that some investors... Precious metals are supposed to be a hedge against inflation. I think some investors are interpreting the monetary expansion of the Federal Reserve, which has been very strong, money supply growth year over year, recently it's been in the 20 to 30% range. And the fiscal stimulus is coming in there as well. I think that the people who dabble in the precious metals markets are sensing that these are inflationary policies. And so it seems to be most of the market hasn't really reflected that yet, but certain parts of the market are acting, to me, like they sense that there's more inflation ahead of us because of the stimulus policies to fight the pandemic.

Jack: You mentioned the stimulus policies, professor, and I wonder if history is a guide there either. You mentioned the pull for American goods and services during war time from abroad. Here, we have the US government stimulating the economy to a degree that I don't know if it's without precedent, but certainly in my lifetime it's rather dramatic $6 trillion, I think, cumulatively being thrown at coronavirus relief. How does that shape how we should think about market implications and the elections, if at all?

Richard: Well, I think that we have to see what the effect of these policies. Yes, it is about 6 trillion. The Fed balance sheet went up about 3 trillion earlier this year from like a $4 trillion balance sheet to a $7 trillion balance sheet. And of course that's what's behind this rapid growth of the money supply. And then Congress has come along with, I guess, about $3 trillion so far of the spending, payroll protection programs, and all that. And so that's a lot of stimulus to an economy and I think the markets should be probably thinking a little more... What I'm saying is that maybe the rise in precious metals prices should be viewed by just investors who don't invest in precious metals as telling them something about the outlook for future inflation. It hasn't really percolated through the whole financial system yet, but I think the precious metals are telling us that there may be more inflation ahead of us, and that will not really be good for the stock market, I think.

Jack: Well, Dick, I'm sure you've been not wanting to hear this question, but you've seen a lot of elections and you've studied even more than you've seen, by a long shot. And so I'd love to put you on the hot seat and just say, what's your prediction for this election?

Richard: My prediction is... I mean, I'll go with the polls, that was the wrong thing to do in 2016 because Mrs. Clinton was ahead of Donald Trump in the polls, and then he got a narrow victory over her. I think this year, the polls are showing that Mr. Biden has a stronger lead over President Trump, and I'm thinking that there are enough worries of what the condition of the country is right now. President Trump can't be blamed for the pandemic, he might be blamed a little bit for how he managed it. But I think this year may be a little bit of a year, like 1932, where the economy is tanking, it was probably worse in '32 than it is this year, in part due to the fact that we've had so much stimulus. Herbert Hoover did a little bit of stimulus, but not all that much. So the economy was in bad shape in '32, and Roosevelt looked like a person who might change things. I think maybe this year Biden doesn't look like so much of an agent of change, but maybe... In short, my prediction is that now, some months before the election, that Biden would probably win.

Jack: All right. So regardless of the outcome sounds like history very likely to be made in a strange economic time. And we thank Professor Richard Sylla from the Stern School at New York University for helping orient us on the history of moments that compare and contrast with where we are right now heading into November. Professor, it was a pleasure to pick your brain a little bit here on Double Take. We wish you the best.

Richard: Thank you. I enjoyed it too.

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