Investors look to policymakers before making financial decisions
NEW YORK — It’s the elections, stupid! Elections — not earnings — are now driving financial markets. It’s about exit polls, not P-E ratios. And a major source of all that stomach-churning stock-market volatility? Blame voters.
Not convinced? Think back to Sunday. When was the last time investors spent Father’s Day keeping tabs on an election in Greece?
Sure, the economy is still a major factor in determining financial security or whether investments rise or fall in value. But the outcome of key elections, such as the one last weekend in Athens and coming votes in the USA and other global hot spots, are likely to have a bigger impact on money-related issues for the rest of the year and beyond, Wall Street experts say. “Policymakers are now the primary market movers,” says Drew Matus, a UBS economist. “Investors are reacting more to per-
ceived changes to policy as opposed to pure economics.”
Indeed, the trajectory of 401(k) balances, mortgage rates, home values, stock prices, Social Security payouts, tax bills and job openings — pretty much anything related to Main Street America’s personal finances — will increasingly be influenced by politicians and policymakers around the globe. The influence of traditional market-moving forces, such as data on corporate profits, consumer confidence, retail sales and GDP, will wane.
The reason: In the wake of the Great Recession of 2008-09, government intervention in financial markets has reached unprecedented levels, says Andy Busch, a public policy strategist at BMO Capital Markets. The health of the global economy is arguably as dependent on government as it has ever been. The era of bailouts, central bank stimulus and politicians-turned-economic-problemsolvers has injected a new wild card into markets.
Shining the spotlight ever brighter on elections is the sheer number of elections in 2012.
Roughly 40 countries will hold presidential elections this year, including seven of the world’s 20 biggest economies, according to an analysis by Daniel Clifton, head of public policy research at Strategas Research Partners. China will also be undergoing a leadership transition in the fall.
“Taken together, countries representing about half of world GDP are holding elections or switching leadership in 2012,” says Clifton.
The timing of the potential power shifts is also critical. Voters from Athens to Austin and in cities such as Cairo, Tripoli, Delhi, Mexico City, Caracas, Seoul and Istanbul, will be heading to the polls at a time when a large chunk of the world is confronting serious economic challenges.
There’s the European debt crisis that is threatening the existence of the euro, slowing growth in one-time global economic locomotives such as China and India, and festering fiscal problems in the USA caused by costly bailouts, tax revenue shortfalls, expensive entitlement programs and a still-sputtering economy.
Not so bullish
Elections are normally bullish, especially for stocks, as politicians looking to boost their chances of winning tend to push through policies that stimulate the economy ahead of the vote. But this year might be different. With many of the countries facing votes weighed down by heavy debt loads, all those IOUs eventually have to be paid, which may “place handcuffs” on their ability to “prime the pump” via tax cuts and spending increases, Clifton warns.
Government’s increased intervention in the economy and markets has emerged mainly in the past four years. The hands-on role is due, in large part, to the fallout from the worst downturn since the Depression. The growing perception of the government as market savior is in sharp contrast to the trend of less government that gained prominence in the 1980s. Back then, a shift toward free markets gained a foothold, driven by U.S. President Reagan and British Prime Minister Margaret Thatcher, and symbolized by the fall of communism, says Nick Bloom, professor of economics at Stanford University.
A major drawback of a government-steered economy is that uncertainty about what rules, regulations and policies will be enacted make it more difficult for businesses and consumers to handicap what the future might look like. That lack of clarity, on things ranging from tax policy to business regulation to how government plans to reduce deficits, has a chilling effect.
Businesses turn “cautious” and are less likely to hire new workers or invest in new factories, says Scott R. Baker, a fourth-year Ph.D. student at Stanford University. Similarly, cautious consumers are more likely to save money than to buy cars, book vacations or fix up their homes.
This type of “policy uncertainty” is on the rise and near historically high levels, according to Stanford’s Bloom and Baker, citing an index they’ve created that measures economic policy uncertainty dating back to 1985. In fact, policy uncertainty was far higher around the time of the bankruptcy of Lehman Bros., the debate over the TARP bailout package and last summer’s debtceiling debate than it was following the 9/11 terror attacks and the second Gulf War.
Their research shows that about half of all daily stock market swings of 2.5% or more since the financial crisis have been caused by the actions of policymakers and their statements about budgets, bailouts and regulatory reform.
So why do elections matter so much to investors? “When the government is driving markets, you really care about who the government is and who is in power,” says Bloom.
Investor uncertainty
Change is another factor. There is uncertainty about who is going to win and what they will do.
Will they raise or cut taxes? Will they trim or maintain entitlement programs such as Social Security? Will they renege on previously agreedupon bailout deals? Will they promote policies that favor growth or austerity? Will they cater to the rich or the 99%? Will they be pro- or antibusiness? And in Europe’s case: Will bankers and wealthy countries come up with the cash to bail out banks and countries buried in debt?
“Who gets elected will have a big say in what happens,” says Matt Slaughter, finance professor at Dartmouth College’s Tuck School of Business. “Part of what investors are grappling with is that they don’t know what policies will actually be put in place.”
Complicating matters is the fact that the tenuous economic situation policymakers now face has never happened in their lifetime, which means there is no “playbook,” Slaughter adds. A policy mistake can be the difference between a bullish outcome for markets and a bad one.
Nor, despite protests from working-class voters who see their standard of living eroding and job security dwindling, is there any consensus among politicians on the best way to fix things.
Political polarization often results in the rise to power of fringe parties, more extreme views on the best way to move forward and even more government involvement. “It’s a double whammy,” says Bloom. “You end up with a more polarized and more interventionist government.”
Economic outcomes
The stakes have never been higher. The reason: Election outcomes will drive economic outcomes.
In many ways, the immediate fate of the eurozone was at stake when Greek voters went to the polls. The fact that the winning New Democracy party is committed to Greece staying in the eurozone and living up to its bailout commitments took the worst-case outcome off the table.
Had the left-leaning party won, Greece likely would have reneged on its bailout deal, which would have led to a default and a speedy exit from the euro. That less-market-friendly outcome would have resulted in massive and hard-toquantify financial disruptions throughout Europe. It also would have increased the odds of financial contagion and exacerbated problems in other highly indebted countries, such as Spain and Italy. Spain is also facing a severe banking crisis, creating further jitters for investors waiting for policymakers to act to avoid catastrophe.
Irate citizens unhappy with their economic plight have already toppled European leaders whose policies they disliked. In May, French president Nicolas Sarkozy, who viewed fiscal austerity as the best way to reduce rising debt loads, lost to socialist Francois Hollande, who favors progrowth policies. Last year, Italy’s prime minister Silvio Berlusconi resigned amid questions about his economic stewardship.
And what happens in Greece or Spain or China could affect what happens on Wall Street.
There’s also an awful lot riding on the November elections in the U.S. The race pitting President Obama vs. Republican challenger Mitt Romney is, in many ways, a vote on whether Americans want more or less government involvement in their financial affairs, says Matus at UBS.
Obama believes government involvement in the economy is necessary to ensure that the middle class gets a fair shake. He says the rich should pay more in taxes to reduce the deficit and keep the safety net for working Americans intact. Romney believes lower taxes, less government regulation and more business-friendly policies are the best ways to get the economy going again.
“People are trying to figure out if they want to follow Obama’s path or Romney’s path,” says Matus. “Do we want a free-market world or a less-free-market world?”
Most everyone on Wall Street agrees that some form of fiscal retrenchment is needed to get the USA’s finances and economy back on track. A so-called fiscal cliff looms on Jan. 1, 2013, less than two months after the presidential election.
On Jan. 1, unless Congress votes to extend them, all the Bush tax cuts will expire, which means Americans will pay more in taxes on their income, including on stock dividends and capital gains. Barring an extension, the 2-percentagepoint payroll tax reduction also expires at the start of 2013, which means less cash on payday. And automatic spending cuts resulting from the congressional supercommittee’s failure to agree to deficit-related spending cuts last November also kick in at the same time.
“If you add all (of those potential fiscal drags) up, you end up in recession,” says Matus.
Says Jason Pride, director of investment at Glenmede, “There are a lot of things up in the air going into the election.”
For the stock market to react favorably after the U.S. elections, whoever wins must come up with a credible plan to stabilize the nation’s debt situation, says Barry Knapp, head of U.S. equity portfolio strategy at Barclays Capital.