Kass: Investors Ignore Politics at Their Peril

This column originally appeared on Real Money Pro on March 9 at 11 a.m. ET

NEW YORK ( Real Money) --In normal times, presidential elections are important to the economic and stock market outlook, but this is not a normal period in our financial history, as huge fiscal imbalances are the elephant in the room in most of the world's economies. So, political consequences loom even larger than normal in their influence on the markets.

In the U.S., our politicians have thus far failed to unite in addressing our growing fiscal imbalances. The relationship between the Republican and Democratic parties has deteriorated in a divided and divisive setting in Washington, D.C. There is no chance of fiscal reform in 2012, and, dependent upon the election results, reform may not even be likely in 2013 or beyond. (Given the gravity of the imbalances and the need to address them (sooner than later), this would not be a market-friendly development.)

In Europe, a strong commitment to stemming the debt contagion is essential in providing a foundation for future economic growth. So far, policy has contained the problems, but the situation remains fragile and the heavy lifting of austerity lies ahead.

That said, based on the strength of the recent market rally, it can be argued that risk assets are paying little attention to politics in the U.S. and in Europe.

This is a mistake.

Investors should pay attention to the growing odds of Obama and Hollande victories in the U.S. and France, respectively, as recent trends, indications and polls suggest that these likely victors will not be risk-asset-friendly developments.

U.S.

Politics aside, most investors agree that a Republican presidency and control of the Congress is more market-, business- and economic-friendly than if President Obama regains the presidency in November 2012.

While it is generally expected that Mitt Romney will be the Republican presidential nominee ( Intrade gives this eventuality an 85% chance), the extended Republican caucus and primary process has weighed on the odds of a Republican presidential win. ( Intrade gives an Obama presidential victory a 61% chance.)

I suspect that once Romney wins his party's nomination, the odds and polls will tighten up somewhat. Arguably, Romney has been forced by Newt Gingrich and Rick Santorum to adopt a more conservative stance (that he probably believes in). This has served to turn off independents. Once he is the nominee, however, Romney will likely move toward a more centrist position and regain some of the independents lost over the past few months, which should tighten up the contest a bit.

Nevertheless, it remains my baseline expectation that President Obama will defeat Governor Romney, a negative for the markets. (We should closely watch the president's approval ratings. Obama now is at 48% in the Gallup Poll. The incumbent always wins when the presidential approval rating exceeds 50%. Below 47%, the incumbent always loses. So between 47% and 50% is the grey area.)

In terms of the House of Representatives, most pundits expect the Republican Party to maintain its majority. Currently, Republicans have a 25-seat majority and the consensus is that they will only lose about 10 seats. The Senate majority is currently six seats (53/47) in favor of the Democrats. The Republicans will likely win between three and five seats. If President Obama wins the election, since the vice president is a tiebreaker, the Republicans need would need four seats to gain a Senate majority. If Obama loses, the Republicans would need only three seats to regain majority.

France

On April 22, 2012, the French presidential election will be held.

The likely outcome of a Socialist victory is not a friendly influence on risk assets as the Party is generally against the German/French bailout of Greece and other joint-country initiatives. Moreover, a Socialist win would endanger attempts to fiscally integrate the eurozone. In turn, this could compromise market-friendly ECB fiscal policies.

Socialist Party leader Francois Hollande leads incumbent Nicolas Sarkozy, the probability pundits are at a 66% chance that Hollande will win the presidency, while Sarkozy is only at 34%. According to Ladbrokes.com, Hollande's odds are at 3-7 and Sarkozy at 3-1.

Summary

The outcome of the presidential elections in the U.S. and France will weigh importantly on the outlook for the world's economies and stock markets.

At the current time, risk assets are ignoring the ramifications of likely Obama and Hollande presidential wins, respectively, in the U.S. and France.

This is a mistake, as the current polls suggest that the outcomes will be market-unfriendly.

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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