(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)It’s a great day to be an American! Although that’s true every day, it’s especially true after election day. Far too many people take for granted what our forefathers fought and died for to make this possible. Just think what goes on around the world. Citizens of emerging democracies stand in lines for hours and hours, risking being intimidated, beaten and even killed to cast one single vote in what may end up being a rigged process.
It seems like our country has increased its level of fickleness when it comes to the big elections. 2008 was a resounding and embarrassing defeat for Republicans that was supposed shake the party to the core. Only two years later, the red states completely thumped the blue, the likes of which hasn’t been seen since the 1930s. Now, this is supposed to be a shot across the bow to Democrats to wake up or 2012 is going to be ugly.
I watch and read an awful lot of market and political pundits and no one has been able to get to the root of the dramatic change. I understand all about Iraq and the economy and jobs and deficits and spending, but there’s some hot topic every election. Americans seem to want instant solutions to problems more so than at any other time. Maybe it’s the tsunami and speed of all the information we’re exposed to? I really don’t know.
Getting back to the election and the markets, we now have a split Congress, something that’s not exactly typical in this country. As you can see from the chart below thanks to dshort.com, there is not much history to use in order to guide us on what the markets usually do in this case. They performed well in the 1980s, poorly in the 1930s and fair in the 1910s. I have heard many people confuse a split Congress with an overall split of the President on one side and Congress on the other. That worked very well for the markets under Reagan, Bush I and Clinton, but not so great in 2008.
On election night, America spoke loud and clear. People hated what George Bush did and now they hate what Barack Obama is doing. For the work that I do, the only things that matter are what was the market expecting and how did it react. Just before the election, I had this to say in my Street$marts newsletter.
“With the stock market just completing 10 good weeks, certain things are now baked in the cake. Check out Intrade.com for a few examples. Republicans are poised to win at least 60 seats in the House, unseating Nancy Pelosi et al. I'd like to be a fly on the wall when she hands over the gavel to John Boehner. Are they civil to each other? Does she smash him over the head with it? What wisecrack comment does he let slip?
In the Senate, it's expected that the Republicans gain major seats, but do not gain control. It's hard to believe that Harry Reid could actually lose his seat, but there is precedent in the House with Tom Foley (I think) and not in the Senate. Anyway, that's what the stock market is expecting.
If we see Linda McMahon in CT come from behind to win the Senate seat or Barney Frank lose his seat in MA, something much bigger will occur. Conversely, if Harry Reid retains his seat and a few of the "locked" Republican seats don't turn out that way, Barack Obama may get an early boost in his reelection bid. I think the bottom line is that the higher the turnout, the more it favors the Republicans.
Turning to stocks, the few days before and after the election are usually positive. We've seen a very strong rally and a "sell the news" mentality would not be the least bit surprising, whether it's right away or a few days later. On the other hand, I would be surprised if stocks launched higher after the election and did not come back to earth soon thereafter.
Let's turn to more "ifs". If the Republicans' expectations end up being a lot of hot air, I would put my hard hat on as stocks should see some nasty downside in the coming weeks. Taxes would surely increase next year along with more regulation and government spending. As of now, if Congress does not act, Americans will be punished with the largest tax increase in the history of our country.
If Republicans somehow take control of the Senate, the most unlikely of all scenarios, the odds favor a strong surge higher. But I would expect whatever initial move to be quickly reversed over a the following few weeks. The overall market theme based on the election is that volatility should increase greatly, at least over the short-term.
Besides the election on Tuesday, we also have Ben Bernanke's shindig with the FOMC on Wednesday. While no one on earth expects Ben to touch rates, the markets have been waiting on the edge of their seats for the final announcement of QE2 (running the printing presses 24/7). Although initial expectations were for another trillion to be created by purchasing more treasury bonds over a period of months, that has been tempered to at least $500B.
As a side note, it's pretty amazing that we use the word "only" and five hundred billion in the same sentence. And so cavalierly throw around the word "trillion". Like they're nothing! It almost feels like we've accepted all this nonsense matter of factly.
So on Wednesday morning, we'll get immediate market reaction to the election and then the Fed's news at 2pm. And let's not forget the employment report being released Friday at 8:30am. If stocks somehow hold up this week and rally into and on that news, I imagine that will spark a key reversal to the downside, giving back whatever gains were made during the week in short order. On the treasury bond side, given their weakness coming in to this week, I would expect (as with stocks) a significant increase in volatility, but a rally as stocks pullback.”
As expected, the markets had a very muted response to the election as there were no real surprises. Later that afternoon, also as expected, the Fed announced their second round of Quantitative Easing (QE2) where they are going to create $600B to purchase treasury bonds of varying maturities over the next 6-8 months. After an hour of volatility, stocks chugged higher but bonds sold off hard as Bernanke’s plan didn’t include as many long dated bonds as expected. No huge deal…
And as I type this, stocks are soaring; gold I soaring; oil is soaring; bonds are soaring; and everyone is parting like it’s 1999! By the time this posts, the October employment report will have been released at 8:30am. Given the rally over the past week, etc., I would imagine it comes in better than expected and stocks open up strongly. If that’s the case, all major indices will be trading at new 2010 highs, along with many sectors.
How much better could it get?
Based on history, if that scenario unfolds, I would expect a downside reversal to begin to take shape within a day or two. I didn’t believe stocks would explode higher without pulling back before this week and I still don’t. A really good jobs report should create some exuberance and that usually spells at least short-term trouble for the markets.
FYI, I will be on CNBC’s The Call today (11/5) at 11:05am, analyzing today’s employment report and again on CNBC’s Squawk on the Street next Tuesday (11/9) at 9:35am discussing the markets’ next move.
Feel free to email me with any questions or comments at Paul@investfortomorrow.com.
Until next time…
Paul Schatz
Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/
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