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Doug Kass on The Business of Politics

Possible Election Outcomes and Probabilities

  • A relatively comfortable electoral college win by Obama in which the Democrats keep control of the Senate -- 40% probability (baseline expectation): The fiscal drag is about 1%-1.5%, and 2013 real GDP growth is 1%-2%. Republicans briefly oppose Democratic policy but quickly acquiesce to Democrat policy initiatives. Stocks are range-bound and have limited downside (S&P 500 1390-1400) and limited upside (S&P 500 1450-1470) over the balance of the year.
  • A narrow Obama presidential win and the Democrats retain control of the Senate -- 15% probability: The fiscal drag is 1.5%-2% (Republicans' opposition to Democratic policy continues for a few months, but, ultimately, they acquiesce. Stocks are range-bound and have limited downside (1390-1400) and limited upside (1450-1470) over the balance of the year.
  • A narrow Obama presidential win and the Republicans regain control of the Senate -- 10% probability: The fiscal drag is 1.5%-2.5% (as partisanship escalates), and 2013 real GDP is barely positive. Stocks have 1350-1400 downside and limited upside (1450-1470) over the balance of the year.
  • A narrow Romney presidential win and Democrats keep control of the Senate -- 20% probability: The fiscal drag is 2%-3% (as partisanship intensifies), and 2013 real GDP is flat to negative. After an initial but brief market rally, stocks have 1350-1400 downside and limited upside (1450-1470) over the balance of the year.
  • A narrow Romney presidential win and Republicans regain control of the Senate -- 10% probability: The fiscal drag is 1%-2% -- Democrats' opposition to Republican policy continues for a while but begins to abate as time moves forward -- and 2013 real GDP growth is 1%-1.5%. Stocks have limited downside (1390-1400) and limited upside (1450-1470) over the balance of the year.
  • A relatively comfortable electoral college win by Romney and Republicans regain control of the Senate -- 5% probability: The fiscal drag is about 1.0%-1.5% -- Democrats' opposition to Republican policy continues for a brief period after which they give in to the Republican agenda -- and 2013 real GDP growth is 1%-2%. Stocks will likely rally in the near term. Over the balance of the year, equities would have limited downside (1390-1400) and upside to about 1470-1500.

Investment Conclusion

In summary, over history, it is the position of where we are in the economic and business cycle that usually holds the key to the future for stocks rather than the outcome of the presidential elections.

Today, the trajectory of economic growth in the U.S. is about 2% in real terms. Profits are estimated by the consensus to rise by about 5% next year.

Every economic and political cycle is nuanced, however, and in 2012, the closeness of the election's outcome (affecting how deep or shallow the fiscal cliff might be) will be an important determinant as to where our economy, corporate profits and stock markets are headed.

While it is important to recognize that the eventual resolution of our deficits will be importantly influenced by who wins the presidential election, regardless of who wins in November, the uncertainty of how our fiscal imbalance will be resolved will be with us for many months after the election. This should serve to limit the market's upside in price and weigh on valuations over the balance of 2012 and into next year.

Just as the market's downside is somewhat protected by the global monetary easing put and the upside is limited by current challenges to earnings, both the upside and the downside of the U.S. stock market and our economic future remains inexorably linked to how close the election will be.

From my perch, the closer the election, the worse the outcome for stocks, corporate profits and economic growth.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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