This column originally appeared on Real Money Pro at 8:30 a.m. EDT on Oct. 22.
NEW YORK (
) -- My baseline expectation is that the November election is still the President's election to lose and that Obama will win with a reasonably comfortable electoral college margin of victory (of 35 or more votes) and with a majority of the popular vote. I am also assuming that the Democratic Party maintains (in a cliffhanger) control of the Senate, while the Republican Party easily keeps control of the House of Representatives.
I am not injecting my own political view. Rather, I am drawing from the most thoughtful and balanced polls extant, with my baseline election outcome being heavily weighted by the input from "
," as I have found his methodology to be more analytical and objective than most of the other pollsters and, most importantly, his past forecasts have proven to be among the most correct.
Silver predicts that Obama has a 68% chance of winning (I am at 65%, see below); he projects Obama receiving a 50.0% popular vote vs. Romney's 48.9%; and he is forecasting that Obama wins 288 electoral college votes against Romney's 249 electoral college votes. In addition, my base case is partially influenced by
, which could change in the days ahead.
While I am mindful of the general view that a Republican presidential and Senate win next month would be more market- and business-friendly than a Democratic win, there is little historical correlation between stock market and economic health based on which of the two Parties' nominees win. I can show as many examples, over time, when a Republican presidency is
market- and business-friendly as I can in demonstrating that a Republican presidency
market- and business-friendly. The same holds true for the Democratic Party. Sometimes a Democratic victory presages economic growth and a vibrant stock market, but the opposite occurs with about the same frequency. (I will spare you the historical comparisons because you will, no doubt, be inundated with these historical tables over the next two weeks.)
In reality, we have to recognize that every political cycle's impact on the business and market cycle is nuanced and can't be easily generalized.
There is, however, a far stronger correlation between where we are in the domestic economic/profit cycle and future stock prices than the election outcome's impact on the future path of the U.S. stock market.
Currently, the domestic economy is showing about a 2% growth rate in real terms, a trend line growth rate that would probably continue into 2013, were it not for the uncertainty of the fiscal cliff.
The Wild Card Is the Fiscal Cliff
Conditions are always different and, as I wrote earlier, nuanced.
To me, the big difference today (from prior election periods) in terms of gauging the election's impact on stocks is the existence of the fiscal cliff.
It bothers me (and has begun to bother the markets recently) that neither President Obama nor Governor Romney has credible plans for dealing with this threat without risking an economic reversal back into recession.
To me, in the upcoming election, what is more important for the business, economic and stock market outlooks than the possible election outcomes (which party wins the presidency, Senate and House) or where we are in the economic/business cycle is the closeness of the presidential race.
I recognize mine is something of a variant view, but let me explain.
Consider that the closer the election's outcome, the more negative it will be for fiscal cliff compromise and for the markets, as there will likely be intense animosity and partisanship. Even though the consensus view is that a Romney presidential win will be market- and business-friendly, my observation (and more bearish market outlook) applies to either a narrow Obama or a narrow Romney victory.
My baseline election expectation of a relatively comfortable Obama presidential victory coupled with the Democratic Party's retention of Senate control will likely have only a limited market impact (plus or minus 3% in the averages over the balance of 2012), as I believe it has been materially discounted. This outcome will probably be dealt with by kicking the can down the road for several months until the losing Republican Party acquiesces to many of the administration's fiscal policy efforts.
A close election, however, that results in either a narrow Democratic or Republican victory, will likely be problematic (for the fiscal cliff and markets), as it will produce a partisan impasse similar to what we have experienced in the past (e.g., during previous budget deliberations). Though it is hard to envision no action being made, even in this circumstance, it will likely hold negative market implications.
Off of my baseline election expectation (Democratic presidency and Senate victories), I am assuming that the fiscal cliff should produce a 1%-1.5% fiscal drag in 2013. (Fortunately, an acceleration in the domestic housing recovery and some pent-up demand in other sectors will likely offset a portion of this drag but will translate into aggregate real GDP growth of only 1%-2% next year.)
Under this scenario, profits will likely be slightly weaker than the consensus forecast of top-down
earnings of $108 a share and much weaker than the consensus forecast of bottom-up S&P 500 earnings of $113 a share, likely falling to about $100 a share from the $103 a share projected in 2012.
If the election results are tighter than I expect and Obama prevails, stocks could drift irregularly lower over the balance of the year, perhaps in the 1350-1400 range for the S&P 500. (Even if the market's drop is contained to 3%-5%, however, many higher-beta stocks will continue to be rocked, as has been the case over the past week.)
If Romney wins in a tight contest (and the Democrats regain control of the Senate), I would expect a brief stock market rally that peters out in the face of the reality that the Democrats will fight tooth and nail and we could fall harder off of the fiscal cliff. As a result, the fiscal drag would be more powerful, and 2013 real GDP growth could fall flat while S&P 500 profits might decline to $95 a share level or lower.
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. In all likelihood, this albatross of uncertainty will weigh on the markets throughout the balance of this year and into early 2013.
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.
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.