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Health & Fitness

Why the presidential race matters to investors

Chief Market Strategist David Joy discusses the presidential election's potential impact on bonds, taxes and other issues important to investors.

With the presidential election now just five weeks away, whether it makes any difference to investors who wins is a question that is being asked with increasing frequency. After all, the U.S. economy is expected to grow only modestly next year and the president can exert only so much influence on it. And regardless of who wins and who controls Congress, the budget deficit issue must be addressed.

Despite an apparent edge in the polls by the incumbent, especially in the all important swing states, it is not clear that stock prices reflect being influenced by the election. Inasmuch as stocks have rallied recently, it could mean that the markets are anticipating an Obama victory and are comfortable with that. But that seems like a stretch. More likely, stocks have yet to exhibit much of any influence from the campaign, reflecting instead a combination of central bank activism and weak economic fundamentals. That could mean that the outcome is still in doubt and that the upcoming debates might still influence the outcome, in which case stocks might yet react.

Whatever the case, and regardless of one's ideological persuasion or party affiliation, who wins the election will, indeed, matter for investors.

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One concern is the future tax-exemption of municipal bonds. While this issue will not likely be on the front burner until the budget deficit debate is fully engaged, both candidates have left open the possibility of a reduction in such bonds’ favored tax status. The president's tax proposal would presumably cap the benefit of itemized deductions for upper-income taxpayers, including the interest on municipal bonds. If such a plan were to take effect, it would ensnare bonds that are already outstanding. Governor Romney has not eliminated the possibility that, in an effort to streamline and simplify the tax code, newly-issued municipal bond interest would be taxable, although there would be no change for outstanding bonds. However, while neither plan is particularly attractive to municipal bond investors, at this point neither plan is thought likely to become law. State and local bond issuers would protest loudly that their borrowing costs would rise as the federal government attempts to balance its budget on their backs. But the issue is out there, and how it is addressed will depend on the election's outcome.

If one candidate is more likely than the other to play hardball with the impending fiscal cliff and allow it to take effect in an effort to gain political advantage, it could trigger a recession in the first half of next year. The sequestered spending cuts under that scenario include a reduction in the amount of subsidy received by issuers of taxable municipal Build America bonds. Depending on the structure of these bond issues, the subsidy reduction could trigger extraordinary call features, disrupting investor expectations of anticipated returns.

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A first-half recession would also come as a rude awakening for investors who, in an effort to squeeze extra income from their portfolios, have invested in lower-quality bonds. Credit spreads have compressed sharply as a result of this strong buying demand, leaving high-yield bonds vulnerable to a selloff should investors reverse course and seek out higher-quality issuers in the event of an economic downturn. Even if the odds of a first-half recession next year are no higher with one candidate than another, remember that the history of the presidential cycle shows that the first two years of a new term are typically the worst for stocks, with the vast majority of bear markets beginning (and, mercifully ending) during them. That does not mean that a bear market is preordained. But if the fiscal cliff is not postponed, or eliminated entirely, the conditions for one to emerge would certainly be in place.

Proposals to change the tax bracket structure, as well as the rate of taxation on dividends and capital gains also vary widely by candidate. Governor Romney has proposed a top bracket of 28% on individuals, but also the limitation of total itemized deductions. He would keep the current 15% rate on dividends and capital gains. The president has proposed raising the top bracket to 39.6%, an increase to 20% in the capital gains rate for high-income earners, and dividends taxed at ordinary income rates for those earning more than $200,000 as a single filer. Corporate tax rate proposals also vary widely.

To state the obvious, the budget deficit problem needs to be addressed. How that gets done is the question. The next president will have the opportunity to frame a proposal according to his vision. So, especially for investors, it does matter who wins. 

Important Disclosures
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

Income from tax-exempt municipal bonds or municipal bond funds may be subject to state and local taxes, and a portion of income may be subject to the federal and/or state alternative minimum tax for certain investors. Federal income tax rules will apply to any capital gains.

There are risks associated with an investment in bond investments, including the impact of interest rates, credit, and inflation. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.

© 2012 Ameriprise Financial, Inc. All rights reserved.

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