Market Impact of a GOP Victory

The following, minus some light editing to protect premium content, was sent to Kelly Letter subscribers last Sunday, October 24.

In Note 40 sent August 29, I wrote that enthusiasm around a sweeping Republican victory in the midterm election would make people optimistic about the economy, and that such optimism warranted our remaining in the market at a time when most onlookers were pessimistic. From the note:

It’s irrelevant for our purposes whether [expectation of an improving economy under Republicans] will ultimately mean anything. If it means that people decide to take advantage of low stock prices ahead of what they think will be a Republican recovery, we could see a sturdy short-term move higher in the market. That’s all we need.

Will it get rid of the long-term realities made clear in Morgan Stanley’s note on sovereign subjects? Of course not. The question will remain “upon WHICH of their promises they will renege, and WHAT FORM this default will take.”

Knowing that, we’ll just root for the Republicans to get people hoping in the market again — and use that ephemeral joy to lock in decent prices before the next down draft.

Now, we’re just a little over a week away from the election and have benefited from the “sturdy, short-term move higher in the market.” With the anticipation phase winding down, we need to look at how the election is shaping up and what the likely outcome will mean to the stock market.

The Senate currently seats 59 Democrats and 41 Republicans. Polls show it ready to become 48 Democrats and 44 Republicans, with eight seats in races too tight to call. It’s not probable, but it’s possible that Republicans will take control of the Senate.

The House currently seats 255 Democrats and 178 Republicans, with two vacancies. Polls show it ready to become 178 Democrats and 220 Republicans, with 37 seats in races too tight to call. It’s a certainty that Republicans will take control of the House. The only question is how much of a margin they will command.

No matter the outcome in the Senate nor the majority’s margin in the House, the result will be called a game-changing victory for the GOP and a repudiation of the Obama administration’s agenda. The influence of the Tea Party movement on the GOP will bring to Washington a new love of austerity — at least in words. We’ll get to deeds in a moment. The words will mean something to us because they’re good at achieving the optimism that keeps investors bidding stock prices higher. The impact on stocks should be an upward pressure on the market. That’s good for us.

Those opposed to the Tea Party like to point out how easy it is to say what we don’t like about the direction of government, to say “no” to rousing applause, to get people “fired up” to not take it anymore. The hard part is when the world calls your bluff and puts you in charge, and then you have to actually manage the situation in a way that’s better than what you swore you wouldn’t take anymore. Supporters of the Tea Party respond that when change is needed, saying “no” to current policy is the first step.

The lead-up to the election and the immediate aftermath of the party of no becoming the party in power has been and will be good for stocks. What about the phase when words become deeds, and we need to derive our enthusiasm from results instead of promises and emotion? It was, after all, not long ago that seemingly everybody loved Obama. Now, Milton Wolf tells us in the Washington Times, “We are witnessing the unmistakable collapse of an American presidency.” Campaigns are glorious. Occupying the office sought is messy. Emotions suffocate in the results vacuum that follows most elections.

What, then, should we expect from a victorious GOP emblazoned with Tea Party stickers? The main policy goal looks to be halting government spending. Ronald Reagan’s suggestion that government is the problem, not the solution reigns supreme over today’s Republican candidates. We need to cut spending, goes the advice, to get America’s balance sheet fixed. There’s a simple follow-up question that remains forever unanswered, however: What will you cut?

The interviews I’ve heard then proceed with the candidate talking about the soaring deficit and the out-of-control debt and a reiteration of the need to cut. But, hangs the question, what will you cut?

Eventually, the idea is the “disastrous” health care reform law, commonly called Obamacare by those who dislike it. That America was in need of a health care overhaul was not doubted by anybody, but what came as the supposed overhaul satisfied nobody. Leaving out any type of public option meant that the left received nothing it wanted. Forcing new regulations on people perfectly happy with their current plans meant the right saw all cost and no benefit. The result is what appears to be a messier mess that is on track to be repealed in parts, if not entirely.

That should be good for the stock market. One undeniable side effect of the health care overhaul was that it left businesses uncertain as to how much their health care burden would increase under the new regulations. That uncertainty led many to hold off on hiring, which has contributed to the high rate of joblessness. A GOP victory that becomes a move to reform or repeal the health care reform effort should provide a positive boost to stocks.

I need to take a moment in this analysis to stress that we’re not examining the moral or humanitarian aspect of health care reform. That’s best left separate from a stock market discussion because, frankly, what would be best for the stock market is a for-profit health care system that never provides care unless it comes with a guaranteed margin. Profit-driven insurance companies, for instance, would see their stock prices double if a law were passed saying that anybody becoming sick could be legally left to die if a review panel of doctors appointed by insurance companies deemed them beyond help. Nobody would support that, of course. Yet, it’s precisely what the stock market would like to see. All we’re considering here is whether the new health care reform law is good or bad for stocks. The answer: bad. That’s why working to change or repeal it will be good for them. The letter must remain agnostic as to what policy is best for citizens.

The health care reform law is a fine cost-cutting target, but rather like targeting as the first point of repair a broken windshield wiper on a car with no tires or engine. There are much bigger, much more important areas in need of attention.

So then, beyond reforming the health care reform, what would the newly elected GOP cut from government spending? Here, the bumper stickers go curiously blank. There’s nothing politically utterable, a problem we’ve faced for as long as I can remember. Let’s make this clear as day. Here’s the US government’s fiscal 2010 spending breakdown:

20% Social Security
19% Defense
16% Unemployment and Welfare
13% Medicare
8% Medicaid and the State Children’s Health Insurance Program
5% Interest on the National Debt

That’s as far as we need to go as it’s 81 percent of the budget. It almost goes without saying that the Tea Party movement is opposed to any tax increases. If so, and it refuses to say it will cut any of the budget categories shown above, then we cannot take seriously its promises to fix the deficit and start paying down the national debt. That’s what Morgan Stanley meant in the note I shared at the end of August. Governments will default regardless of what politicians say. The question is what form of default they’ll choose.

Personally, I would love to hear a candidate say he or she is in favor of more short-term stimulus spending to revive the economy, to be followed by severe cuts in the top five budget items shown above. Nobody will do that, though, because they want to get elected and voters don’t elect politicians who promise to stop passing money along to them.

This is one reason that the long-term picture remains bleak. The spending trajectory will not change meaningfully. It needs to do so, but it won’t. The fiscal imbalances will worsen. That brings us to the next issue that’s likely to arise after the election.

The Republicanized Congress will face a still Obamafied White House. For at least the coming two years, we’re likely to see a calcified government, the old “Washington gridlock” at work to get nothing accomplished. Who will that leave to try their hand at helping the economy? Ben Bernanke & Co. at the Federal Reserve. Remember, they have just one tool left in their box and it’s called the QE crescent wrench. Quantitative easing is the printing of dollars by another name, as you know by now, and such an approach devalues the dollar. There’s a chance that the the QE crescent wrench will have just one more trip out of the box in this recession, but if government leaves the economy gasping for much longer the Fed will feel pressure to do something and the only thing it can do is print more dollars.

That, too, is good for the stock market but for the wrong reasons. You read about that in the Janjuah and Gaynor note from Nomura above. The worst-case scenario taken to its unpleasant conclusion would find the dollar worthless in currency markets and discredited in international circles as commodity inflation chokes the economy in its tracks. Basically, if you think unemployment is bad, consider unemployment plus $10 gasoline and $8 milk.

Ironically, the gridlock that ensues from the Tea Party GOP storming Washington to take on the Obama administration could lead to more debt than ever on the US balance sheet if the Fed creates dollars from daylight to buy government bonds. Such a situation looks plausible.

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  1. Gregory Iwan
    Posted November 2, 2010 at 2:09 am | Permalink

    This lead piece is pretty well stated. Unfortunately, I find that the markets share a number of qualities with politicos. One is the common presence of dragons (or snakes; take your pick). The other is the lack of meaningful promise. Mr. Market “giveth,” and then he taketh away. Bond trading brings to mind some of the more esoteric and more painful realities here. That’s why I like to hold to maturity. Finally, in neither instance — politics and financial markets — do I find anything like “full disclosure.” It’s always caveat emptor. I wonder if voters even listen.

  2. Jim Johnson
    Posted October 31, 2010 at 2:17 am | Permalink

    The message here for investing is bearish for equities. Unfortunately that is my take from Jason and other of the honest, competent market/econ analysts. I personally like Rosenberg, Shedlock, Denninger, Whalen (Chris), Maulden, others.

    The message politically is less clear to me than it is apparently to Don Fey. I’m a conservative, I suppose by the duck test I’m a Republican. I’ve been involved in a few Tea Party activities and their kin. I’d rather be stranded with them on a desert island than the scum that rallied last month in DC or in DC today for that matter.
    The TP’s are a mixed lot, as all movements are. Too much religion for my taste but I’m probably the benefeciary of their faith.
    I don’t find them overly paranoid (comnpare to whom? heard Chris Mathews lately?). I don find them informed, deeply read, more informed about history, policy, political philosophy than alll the lib’s put together.
    From a tactical perspective, you’d have to be nuts to answer the pregnant question during a campaign–ie, how ya gonno cut the spending?
    I actually believe the new breed of Republican will open this question at the right time. It must be opened and answered or the US is going down the tubes or into a type of civil war. (a war fought in the courts by aligned states who refuse to play by the overreaching rules of DC.)
    I’m 63 so I may escape soc sec cuts. But I won’t complain if I have to give up something for the sanity of the system. In my opinion, Americans better wake up to this reality or we will undergo the tradegy of the commons on steroids.
    No questions public unions must be busted or banned. This is a terrorism on the taxpayer. and beyond that we have too many people on some version of the dole. I’d include in that teachers and other school employees K-12, universities; many non-profits; public employees of cities, counties, states and federal; unncessary unions (read SEIU).
    All of the people have a vested interest in expanding government and spending.
    We are at the point that a majority on the dole can vote taxes on those who actually work for a living and create wealth. as it is, 50% of our citizens pay NO TAXES, and some actually get a “refund” of taxes they don’t even pay–that is Orwellian double speak.
    There’s a lot room between the “let ’em die” scenario in Jason’s post and allowing every last person to have state-of-the-art medical care. We better find that sweet spot or we are toast. but we’ll be equal–bad health care for all.
    It is time we renew self sufficiency. Parents need to take responsiblity for their kids rather than expect me to pay a school system to make up for their imcompetence or laziness as parents for example. Farmers (I own a farm) need to start turning a profit without welfare payments, as do many corporations.
    If an individual doesn’t want to be screwed by a credit card company, learn to read.
    families need to start planning for taking care of their own. The rest of us don’t want to be doing it a the point of gun. (aka, IRS).
    We’ve dropped billions into the so-calle war on poverty. How’s that going for ya’? it is as rathole. Those “commuinties” best start figuring out how to do for themselves rather than living on this government run plantation.
    Finally, I suggest all citizens do some real homework on what is happening in Greece and France. We are not far behind unless we get our act together very quickly. If the Republicans don’t get their act together this time around, we’re doomed. You know the Dem’s won’t don anything. They know no other method than buying votes with other people’s money.

  3. Posted October 31, 2010 at 1:34 am | Permalink

    I have always believed in fundamental republican principles. However, those principles have nothing to do with the republican party of today- and I no longer wish to be associated with the label. While all politicians lack character and rarely act in the best interests of the nation, today’s breed of republicans and the associated splinters revel in obstruction and destruction. Should they gain control of the house, they will only assume that the citizens support those objectives and they will have more power to accomplish them.

    The new republicans tend to be inclined toward paranoia rather than partnerships, seeing evil in every person or movement that doesn’t agree with them. This distances them from roughly half the nation who votes for the other side, and leaves those Americans disenfranchised; without a voice… and increases the polarization of the nation. Everything about the current republican movement indicates it prefers to divide rather than unite the country. It has become very personal and adversarial; intolerant of beliefs in conflict with it’s own, and continually moving it’s own center closer to the extremes. It’s not just a few individuals; the party itself seems to be seeking out and supporting the radicals and has lowered it’s own standards to accommodate them. Historically, such actions have been hallmarks of some very dangerous political movements.

    The recovery isn’t moving as fast as we would like, but bear in mind that the same people telling you how little we have gained during the day are also the ones who are building road-blocks to progress after dark. The most important objective of the new republican movement is not to improve conditions, it is to gain power by causing others to fail. Apparently the cost to the nation in the meantime is irrelevant to them, but it’s a frightening one to me.

    If we were wise, the first quality we would demand of any congressional candidate would be honor, the self-regulating instinct and moral strength to do the right thing. If we were wise, we would not allow politicians to do our thinking for us, and we would recognize the effort to distort our perception as the trademark of a charlatan that should never gain power. We are not wise- and while congress is devoid of truly honorable men, some do place the nations’ interests much higher on the priority list than others. It seems all elections are a choice of the least evil, and we know that- yet voters continue to respond to those who pander to their fears rather than those who speak to their hopes and dreams, and we continue to fail to hold politicians accountable to honorable, ethical standards. That is our failing, not theirs.

    Should the new republican mentality prevail in congress, their ability to impede will increase and I believe they will take full advantage of it. The promotion of paranoia and fear will increase. The power of the shadow money and influence will increase. The budget will increase, corruption will increase and progress will slow. Jason’s statement about seeing a “calcified government” will be accurate.

    As any businessman knows that condition is not a neutral one because your competition is moving forward and you are not, thereby falling further behind every minute. Action, even when it turns out to be less efficient or effective than alternatives, is still better than no action at all. Other nations are indeed moving forward, and we are indeed falling behind. A frozen government loses by default- and the nation suffers as a result.

    For us as investors, I think a republican majority in the house means that the recovery will be even further away. A lot of companies are poised to expand now, and have the resources. They have been waiting, sitting tight because the horizon is not clear. They are unsure of the future, particularly unsure of what may happen in Washington, and that is a condition that is largely the result of republican obstructionism. If conditions in Washington get worse, the restraint of expansion, the rate of job growth and the economy will all reflect it. We could be moving sideways for a long time, but that isn’t the worst of it. Many companies survival depends on continued recovery of the economy. Should it slow or stop, there will be more failures that might trigger a deeper recession.

    Lack of firm leadership and direction is a disaster, be it in Washington or the corporate board room.

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