I hate to do it, but I’m going to have to write about politics this week. Believe me, it isn’t something I relish, but in light of the recent election, it would be dereliction of duty to ignore the elephant and donkey in the room. Let’s get this out of the way right up front; Obama got shellacked last Tuesday. Yes, I know he wasn’t on the ballot but as he said before the election, his policies were. And no matter how you look at last Tuesday’s result it is hard, maybe impossible, to say that those policies were not rejected outright by the electorate. If the opposition had offered up a viable plan for economic growth I might be tempted to say that voters opted for better economic policies, but in this case, when Republican strategy consisted largely of not being Democrats, the most that can be said is that they don’t like the current ones or at least don’t like the results the current ones have produced.
The economy was the most important issue on the ballot and regardless of what the economic statistics say about its aggregate health, the public said loud and clear last week that it isn’t nearly good enough. We’ve been pointing out what we believe is obvious for a while now; the economy is far from healthy despite a booming stock market. Growth has been weak and incomes have been stagnant for all but the very rich. It appears that the rank and file, the hoi polloi, agree with that assessment. In fact, if one believes that the markets are always looking to the future, the stock and dollar rallies of the last year may be more properly explained by what happened at the ballot box than what happened down at the Marriner Eccles building where the Federal Reserve meets periodically to perform their monetary rituals.
Of course, that would imply that the policies that will be produced by a Republican congressional majority will not only be effective but actually be enacted. While political gridlock is generally good for the economy and the stock market, I don’t think continued gridlock is sufficient to explain the new record high in the Dow last week. Those driving stock prices higher on the expectation that Republicans will produce better economic policies and that President Obama will sign them into law are bound to be disappointed. I could be wrong but I don’t see much happening on the policy front; the ideological divide is wide and deep.
So what can we expect from the new Congress? I think there are several economic related items that have a chance of being passed by Congress and signed by the President:
1. The Keystone pipeline seems almost sure to pass now that Senator Reid can no longer prevent a vote in the Senate. The economic impact is hard to judge but it is probably less than Republicans claim and more than Democrats admit. And frankly, if oil prices keep falling it might be zero.
2. Fast track trade promotion authority also seems likely to pass, something the President has sought and has been blocked by his own party. With trade deals pending with Asia and Europe this might have more impact than Keystone but that assumes Republicans are willing to give the authority to a President they dislike and don’t trust.
3. Repeal the ACA’s (Obamacare) medical device tax. This is bipartisan and will likely be signed by the President. Economic impact is significant for the companies involved but not much for the overall economy.
There may be some other areas of agreement but if there are I’m unaware of them and if that’s all we get, I don’t think it moves the needle on the economic compass. There will be a lot of talk about tax reform – especially corporate tax reform – but I don’t see a compromise that will pass Congress and gain a Presidential signature. There will be a big fight on immigration reform and the President will probably move ahead unilaterally as he has said he will but what Republicans will pass and what the President will sign are very different things. There will probably be an Obamacare repeal bill passed but that is dead on arrival at the Oval Office.
What Republican control of Congress really means is that the 2016 Presidential election campaign started last Wednesday. Republicans are likely to pass a lot of bills that end up in the veto bin but give voters a better idea of what to expect from a Republican President with a Republican Congress. All I can say is that whatever they pass it will have to be better than what transpired under the last Bush administration, especially if their Presidential nominee has the same last name. And based on the exit polls last week, both parties need to find better candidates than are floating around out there right now. None of the apparent Presidential hopefuls, especially the ones named Bush or Clinton, were favored by the people who voted last week.
As for the stock, bond and other markets, it should be remembered that political gridlock in DC isn’t going to produce better economic policies in Tokyo, Brussels or Beijing and that’s where the greatest threat to the US economy is right now. Our economic policies may have been in the wilderness for going on 15 years but Japan and Europe have us beat on that score by a wide margin. As for China, unlike some who have shown admiration for their ability to “get things done”, I’ve never been particularly enamored of the central planning model. China is facing some very tough decisions in the near future, partly as a result of Japan’s ramped up Yen devaluation project, and none of their choices are particularly appealing. The falling Yen puts a lot of pressure on China and the rest of Asia as well as the commodity producing nations that supply them.
The stronger dollar is an obvious positive for the US and would over time produce better results than anything that might be enacted in Washington, DC but it also introduces new risks to the global economy and financial system. It isn’t mere coincidence that emerging market crises emerge during periods of Yen weakness and Dollar strength. The pressure to match the Japanese devaluation is enormous and mighty tempting to politicians; it seems the easy way out. Unfortunately, the long period of Dollar weakness enticed a lot of foreign governments and companies (and hedge funds) to take on Dollar denominated debt that becomes much harder to service when currencies are falling. Prominent among countries that have taken on too much debt and specifically too much dollar debt (mostly private), is China whose economy is already having trouble. The rise of China and the other emerging markets over the last 20 years means a crisis there will have a bigger impact than in the past when these episodes passed with little long term implications for the rest of the world.
Having said that, I am struck by the extreme sentiment that prevails with regard to the dollar. It seems that everyone believes the dollar has nowhere to go but up and their portfolios are positioned for that eventuality. A similar condition also still prevails in the market for US Treasuries where speculators are still net short in the futures market and seemingly everyone who appears on CNBC talks as if higher interest rates are inevitable. And of course, sentiment with regard to US stocks is about as bullish as it can get. The most recent American Association of Individual Investors poll found a mere 15.1% of respondents willing to don the bear mantle. A contrarian might want to take note and wonder how the prevailing belief that the US economy can decouple from the rest of the world might just turn out to be more hope than reality.
Politics and economics – and therefore markets – are always intertwined. The election last week will certainly have an impact on the economy although it appears to me that it will largely be through continued gridlock and positioning for the 2016 election. There is the possibility I suppose that our politicians actually do come together and get some things done but frankly that scares me more than the prospect of two more years of gridlock. The only thing that frightens me more than one party in complete control is anything the two parties might wholeheartedly agree on. In the meantime, our economy and markets will have to make do with the conditions that prevail both here and abroad, neither of which look particularly robust at the present. Nothing that happened last Tuesday seems likely to change that in the short term.
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