This week's US elections resulted in a status quo outcome -- something that should not have been a major surprise, regardless of how the spin doctors played this campaign. Obama kept his keys to the White House, the Republicans maintained control over the House and Democrats remained the majority in the Senate.
For all the negative campaigning, aimed at shifting an ever-shrinking undecided voter contingent, including Donald Trump's last minute media grab on his $5 million offering for Obama disclosure documents (now there's a man with a real journey into insignificance); America's philosophical divide became even more apparent. Republicans turned out the angry white gentlemen and rural vote, while Democrats solidified their captive hold over urban, Black, Hispanic and female voters.
Much has already been written on how this was essentially the last opportunity for the Republicans to seize power on a declining demographic base of support and, now that Mitt Romney has failed, it is difficult to see how Republicans can adapt quickly enough to win four years from now, if not eight, 12 or more. Option one is to shift towards the centre and welcome the above-mentioned demographic groups with open arms. Doing so would eat into Democrat support, but it would raise the risk of the extreme right splitting away as a separate party (Ross Perot nightmare revisited).
The conservative vote would be split and odds of returning to power would diminish. Option two is to stay the right-of-centre course, thus rolling the demographic dice that what happened this past Tuesday was just an anomaly. One can argue that coming up with a new Republican torch bearer and reconciling these two opposing options will take up so much time over the next four years that the GOP will not be able to govern the House with the singular purpose of opposing everything that comes out of the Oval office. In other words, Republicans cannot risk being labeled simply the "no" party.
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These political dynamics will have an impact on the type of economic policy that comes out of Washington over the next four years, despite suggestions that a status quo election will result in just a status quo gridlock on the changes necessary for an improvement in US fiscal status, production, employment and household net worth.
The easy and skeptical view is that Republicans will follow a scorched earth doctrine, throwing out compromise in favour of a worst-case "fiscal cliff" scenario that sends the US economy into recession and Democratic 2016 wishes along with it.
Similarly, we can view the Democrat position with respect to the revenue (tax increases) to spending mix as unbending and unpalatable to the centre/centre-right make-up of Congress. The reality from the razor-thin margin on the popular vote is that compromise is probably more likely in the next several months than in the Presidential term just passed. The ball is in Obama's court in terms of delivering the first serve and, at the time of writing there was talk that the re-elected President would deliver a speech outlining the initial tactics in arriving at a solution to the fiscal cliff and debt ceiling before inauguration.
The challenge is that markets and rating agencies may not have a lot of patience in waiting for a solution. Let's forget the post-election plunge in stocks for now. This was not the market voting against the Obama victory as much as pundits would have us believe. Instead it had more to do with ill-timed comments by European Central Bank President Draghi that Eurozone tensions are hurting Germany's economy.
That headline hit the wires at just after 7:15am ET -- about the time the floor came out from under the stock market. A day later we were already seeing some stabilization in equities and I expect that markets are going to wait at least a few sessions for signs from the Obama office before making the next move.
Let's not forget the other implications from this week's election outcome.
For one, Fed Chairman Bernanke's job is safe, at least until January 2014 when his second term is up. This means that bottomless pit quantitative easing will continue, which was a factor behind the risk-on trade coming out of the summer. We also have a leadership changeover taking place in China this month.
Right now it looks as though a pro-reform platform will continue, suggesting a stronger push towards creation of a more sustainable domestically-driven growth model for China. I still don't know if Romney would have followed through with his campaign promise to label China a "currency manipulator"; but there is some relief in the fact this indictment won't be made and that an improvement in US-China trade relations can be achieved (with less threat of Chinese retaliation via dumping of US Treasury bonds).
Is this constructive view towards the next four years naïve? Perhaps. Guaranteed, if we had seen a unified election outcome (one party taking the Oval office and Congress), the odds of quick action on the US fiscal problem would have been better, regardless of which party took office.
Would a Republican victory have resulted in an improvement in business conditions on expectation of reduced taxes? Probably. Yet, I don't believe that rating agencies would have rewarded a tax-centric fiscal strategy when deficit reduction is such an overwhelming priority.
For now, investors should remain nimble and err to the conservative side in terms of their exposure to risk relative to their strategic targets. The last four years were far from boring, as the US economy fell into the worst downturn since the Great Depression and stumbled out of it. The next four years will prove to be as interesting and important to our portfolios.