The Circus Is In Town!

same-old-animalsAnd it’s here to stay for a while. This circus is complete with clowns, performers, craziness, and even some wild animals. It has all kinds of acts that amaze the audience by pushing the envelope of reason, rationality, and common sense. Instead of taking place under a big tent however, we get to see it everyday on the TV, internet, and newspapers. In many ways it is the greatest show on earth because it involves some of the most powerful people in the world. What is the name of this circus? It’s called of course the Presidential Election.

I’m writing about this because although we have been watching this circus show now for almost a year, the best is still yet to come with a grand finale likely eclipsing anything we’ve seen in our recent lifetime. Buckle up for the ride. I get asked constantly about how the outcome of this show will affect the markets. What will stocks do if the Democrats win? What will interest rates do if the Republicans win? Will we see lower or higher taxes?

Here are a few important points to remember when linking political elections to the markets.

1. The President’s power over the markets is not as strong as you think. Yes, they love taking credit for a strong economy and everyone blames them for a weak one, but in the end, their only real power over the economy is by proposing tax policy that congress also has to approve, and by instilling a strong or weak regulatory environment. While these both are important factors that do inspire the markets, they rarely are “the reason” why stocks or bonds go up or down. Regulations typically can strongly impinge a particular sector or industry, but rarely have influence over the market in general.

2. The Federal Reserve and other central banks simply matter more. Interest rate (monetary) policies matter much more than fiscal or regulatory policy. For one, you don’t have to get monetary policy through two branches (executive, legislative) of government. It’s simply decided on by the Fed’s board of governors who meet every six weeks. As a result changes tend to happen much more easily and frequently. The world economy is built on credit. And the cost of credit is determined by interest rates, so central banks have an enormous influence on the economy. It doesn’t matter whether developed or emerging, western or eastern, or import or export based, the ability to raise capital trumps all factors when determining the strength or weakness of an economy. The central banks set monetary policy which pretty much determines whether it’s easy or difficult to raise capital.

3. It’s the economy stupid. This of course was James Carville’s famous line during the 1992 election that helped get Clinton elected. He was right of course, but not for the right reasons. Bush had nothing to do with the recession in the early 90’s. Neither did Clinton with the recession that started in 2000. He didn’t create policy that allowed tech companies to reach astronomical valuations on bogus earnings. And this may strike a chord, but W. Bush’s tax and regulatory policy did not bring down the financial markets in 2008. While many believe so, it was rather very low interest rates combined with loose borrowing that led to an ultra leveraged housing market. Did the president tell these lending companies to lend to people who had no business owning a home? Did the president tell the banks to create financial weapons of mass destruction? No. So what did lead to these booms and busts? The economy stupid. The economic cycle is centuries old and like any cycle there are peaks and valleys. Government policy can sometimes extend the life of a cycle, but is rarely the cause for it. And as you well know, we now live in a global economy. So currency rates, interest rates, and capital flows have much more influence on where we are at in the cycle than who is sitting as president.

We believe that this current bull market cycle in stocks is a result of Fed policy and keeping interest rates low for so long. The economy has been puttering along for a while now and while unemployment is low, there really hasn’t been any meaningful growth overall that has anyone excited looking forward.

We still ask ourselves, could this time be different? Could this election be the one that sends the economy into a down spiral? Well…. maybe. But not because of who’s elected. Rather due more to the fact that our country is so divided politically that no matter who wins, a large number of society will be upset. This could greatly affect consumer confidence with an economy that is 70% driven by the consumer. If half of your population is upset and not willing to invest or spend money, then you can quickly see the problems that could arise.

So in the end, sit back, buckle up, and enjoy the show. Because I think the worst, ahem, best is yet to come. Just remember that while the office of the president is very important to not only our country, but the world, it’s not the driving force of the world economy and in the end does not determine how asset classes perform.

Source: Brian Boughner, CFA, CMT