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Monday, 28 July 2014

Market whistles merrily as Romney sinks

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Mitt Romney’s chances of capturing the White House dwindle almost daily and financial markets seem not bothered a bit.

James Saft, Reuters Columnist

Not only have equity markets been buoyant and government debt stable but also both markets show every indication of paying more attention to the fate of Europe and to extraordinary central bank measures than to the election.

Romney’s chances of defeating President Barack Obama in November are down to 33%, according to wagers placed through Dublin-based online betting exchange Intrade, down from 44% as recently as Aug. 27. Since then the S&P 500 has gained 4%, and stands 10% higher than late-June levels. The interest the U.S. must pay to borrow money for 10 years has risen to a still historically low 1.78% from 1.64% in the same period.

The election has developed not necessarily to Romney’s advantage, to paraphrase Emperor Hirohito at the surrender of Japan. Romney, famously, told wealthy supporters that 47 % of Americans will back Obama regardless, consider themselves victims and entitled and that “my job is not to worry about those people,” remarks secretly recorded at a $50,000 per plate fundraiser at a private equity executive’s Florida mansion.

The only scenarios which would be bad – no, terrible – for bonds are a loss of confidence in the U.S. or a recovery, both of which are remote prospects.

Given events and given the markets, you have to conclude that either investors don’t believe the odds or are actually pretty comfortable, or pretty unsurprised, at the prospect of a second Obama term.

None of this is to advocate for either candidate’s policies, and it would be a grave error to assume that rising stock markets are always a positive indicator of a nation’s health, financial or otherwise. It is also important to remember that whichever candidate wins the presidency, his ability to enact policy will depend in very large part on the disposition of the House and Senate.

And, of course, it is possible that markets change their minds about the impact of an Obama victory as the possibility grows nearer, and as the tranquilising effect of the Fed’s latest round of, now open-ended, bond buying, fades.

Taxing, spending and printing

To the extent that politics are driving markets the main macro issues would be taxation and spending. And while there are huge differences in the two candidates’ plans, both sets of policies may have positive or negative impacts on markets, depending on your outlook.

Obama is proposing to raise tax on long-term capital gains to 20% from 15%, and keep current rates for couples earning less than $250,000. He would also keep a planned 3.8% Medicare tax on long-term capital gains and dividends, which Romney would eliminate. Romney would keep the zero and 15% rates on some dividend and long-term capital gains, but eliminate tax on capital gains, dividends and interest for those with adjusted gross income below $200,000.

Those are all figures which argue for a better stock market reception for Romney, and the fact that we aren’t seeing the prospect of these lower taxes slipping away have an effect may simply mean the market was never counting on them.

Both candidates are proposing fiscal tightening, though Romney hasn’t released enough detail to allow for a true side-by-side comparison for next year. Generally it would be fair to expect deeper cuts, over time, from the Romney camp, cuts which would, by definition, reduce the amount of cash flowing into corporate tills.

And there is the threat of the fiscal cliff, over which the U.S. will plunge, with automatic spending cuts and tax hikes, in 2013 if no agreement is reached. The fiscal cliff would be toxic for equities, and any electoral result which makes it less likely will be good news for equities.

The only scenarios which would be bad – no, terrible – for bonds are a loss of confidence in the U.S. or a recovery, both of which are remote prospects. If we fiscal cliff-dive, the ensuing recession will drive yields still lower and, perversely, even a downgrade of the U.S. may back a short-term rally in government bonds as investors seek to compensate for increased risk by selling still riskier things like stocks and corporate bonds. If we slowly, or quickly, reduce the deficit, growth will suffer and bond prices rise.

The real underlying force in financial markets isn’t politics but monetary policy, as the Federal Reserve yet again pulls out the stops in an effort to breathe life back into the economy. Conventional wisdom is that the ECB has vastly reduced tail risk out of Europe, which is a huge boon. Even the Bank of Japan is once again adding to the global liquidity party, announcing the latest in an as yet unsuccessful series of bond purchases.

Taken together those actions are giving markets an upwards – arguably artificially supported – bias. That may last until the election but we will need to see some better economic data soon for it to be sustained.


(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. jamessaft@jamessaft.com)

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