Posted by on October 12, 2016 2:17 pm
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Categories: Capital Markets donald trump Economy Equity Markets Florida Indiana new york city Volatility Washington D.C. white house Yield Curve

Grid systems are easy to navigate on foot and (presumably) horse and carriage, but a visit to any grid-based city today reveals that they are ill suited to more modern conveyances.  Invariably someone misjudges the speed of traffic at an intersection and blocks the path of the crossing street.  That’s called “Gridlock”, a term coined by a New York City (where else?) traffic engineer named Sam Schwartz in the 1970s and popularized during a subway workers’ strike in 1980.

Washington has its own version of gridlock, of course, and it has nothing to do with the street layout. Political gridlock occurs to varying degrees when House, Senate and White House are controlled by different parties. And despite the relatively recent origins of the word “Gridlock”, DC’s experience with the phenomenon go back a lot further than 1980. A few points:

  • Since the end of World War II, there have only been 13 times (26 years) when the President and the majorities of both chambers of Congress shared a party affiliation. They were under Truman (1945-1947, 1949-1951, 1951-1953), Kennedy (1961-1963), Johnson (1963-1965, 1965-1967, 1967-1969), Carter (1977-1979, 1979-1981), Clinton (1993-1995), Bush (2003-2005, 2005-2007), and Obama (2009-2011).  Source:http://wiredpen.com/resources/political-commentary-and-analysis/a-visual-guide-balance-of-power-congress-presidency/
  • For the remainder of the 71 years since 1945, Presidents have had to share power with Congress.
  • Investors with long memories will recall the later Clinton years (1995-1999) and all of President Reagan’s time in office (1981-1989) as especially productive times for U.S. equity markets.

It is no surprise, therefore, that equity markets seem to like Washington’s version of gridlock.  There is the practical point that two of the most notable bull markets in recent memory occurred during a split of White House and Congressional party control.  And then there is the philosophical appeal of balanced governance, with (at least theoretical) give and take to the political process.

Then there’s the current election cycle, full of sound and fury.  Until recently, the general market narrative was that Secretary Clinton would win, probably narrowly.  Republicans would hold the House (currently a 246-186 advantage) and the Senate (54-46 advantage) as well.  Gridlock would continue, for better and/or for worse.

With polling after Sunday’s debate favoring Clinton by a wider margin than last week, markets will have to consider another outcome: that the Republicans lose the Senate and possibly the House as well.  House Speaker Paul Ryan is clearly worried enough about this outcome to distance himself from candidate Donald Trump.  I don’t know much about politics (especially as compared to many readers of this note), but when a major party leader backs away from a presidential candidate late in the campaign that can’t be a sign things are going well.

So how much of a risk is a Republican loss of House or Senate?  Here are a few resources you can use to track the probabilities over the coming weeks:

On the face of it, Republicans don’t have much to fear but this is anything but a normal election cycle.  There is still enough time for an “October surprise” that hurts either candidate, of course. And perhaps the polling data that shows candidate Trump falling back is as flawed as the surveys that assured us Brexit was unlikely.  We won’t know that until Election Day. 

In the meantime, markets have to “Dance with whom they brung”, and that companion is the domestic political scene.  Today’s market action was telling in that regard.  A few final points:

  • Health care took a shellacking, down 2.5%. It was this move that got us thinking about the whole topic of markets and politics.  Pick your favorite metaphor – lightning rod, coal mine canary, whatever – this group will be very sensitive to the final weeks of U.S. political polling and the actual outcome of the election.  Given that at least part of a Clinton win would come with the support of those to the party’s political left, the health care industry would certainly be in the cross-hairs of a Democratic President and Congress.  
  • Small cap stocks also took it on the chin, down 1.6% to 1.8%. Part of that was certainly a risk off move, since large caps were 1.3% lower on the day.  But these smaller public companies tend to have a larger exposure to the U.S. economy and regulatory structures than large cap names.  To the degree investors worry about a uniformly Democrat Congress/White House, these names may see more volatility in the weeks to come.
  • Financials actually outperformed today (only down 0.9%), likely as a result of a steeper Treasury yield curve. Still, like Health Care this would be another sector where investors might fret over incremental regulation should Republicans lose control of Congress.

I would emphasize two final points. First, I have no dog in this hunt. Unlike many of you, my political inclinations run shallow and certainly never touch my heart.  The point of this note is to relay several points of interest about capital markets, not to wave a red or blue flag.  Secondly, the polling data for the House and Senate races seems to predict a continuation of the status quo.  But in the final month of this highly unpredictable election season, that could (and we’re guessing it will) change.

The article, "Political Risk Strikes US Equities", was syndicated from and first appeared at: http://feedproxy.google.com/~r/zerohedge/feed/~3/fl4hdyYQ3mM/political-risk-strikes-us-equities.

You may find more great articles by Tyler Durden on http://www.zerohedge.com/fullrss2.xml/sites/default/files/images/user5/imageroot/draghi/CBO%20August%201.png/%2A%7CFORWARD%7C%2A.

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