Romney and the Market

"An election is coming. Universal peace is declared, and the foxes have a sincere interest in prolonging the lives of the poultry." - George Eliot

"Now, let me be clear. The path I lay out is not one paved with ever increasing government checks and cradle to grave assurance that government will always be the solution. If this election is a bidding war for who can promise the most goodies and the most benefits, I'm not your president. You have that president today." - Mitt Romney

Now I am not a politician.  Never have been and I don't plan on ever being one, it is just not me.  However, this election is going to have a dramatic impact on the market if Mr. Romney is elected AND if he stands by his election campaign rhetoric.  As I have repeatedly mentioned in previous blog posts, the fate of the market is in the hands of the politicians.  Never in my 25 years of trading the markets has it been this skewed towards their policies.

The main reason for this is that over the last few years government has been taking a larger and larger share of the market from buying up Collateral Mortgage Obligations (CMOs) to owning large blocks of GM and other companies to printing money in order to stimulate the market (Bernanke's words not mine).  So the government through the Federal Reserve is trying to manipulate market prices and so far as the stock market is concerned it is working.  But with an election looming what would happen if Romney gets elected?

The first thing he has mentioned is that he will remove the head of the Federal Reserve, Ben Bernanke, and replace him with someone that is of similar mind to his own.  Based on the quote above that would mean cutting the money printing from the Federal Reserve and working towards balancing the budget.  Without the support of the money printing machine the stock market will be destroyed and already it is showing signs of tiring and this is not being helped by poor results from bell weather companies such as IBM, Google, Microsoft and Apple.

So what of the bond market and interest rates?  At present due to the continued economic weakness any elected president requires that interest rates remain subdued.  If interest rates spike any form of recovery will be dismantled and there is no chance of balancing the budget as increased interest payments will offset any cuts in spending.  There is one caveat here though, if the United States is seen to be more austere then there is a fair probability that the reward will be continued low rates.  How low is a big question but I would be surprised to see rates on the 10 year note rise above 2.5% to 3.0% for the simple reason that during a stock market meltdown, demand for safety becomes tantamount and at present the only safety left is either gold or bonds.  Furthermore while rates may start to rise higher, whomever is the Federal Reserve Chairman will have as his or her mandate that rates need to remain low. 

So how can this be done without continued printing of money?  He would have to rely on international buyers of United States debt.  The Germans would argue that being more austere should lead to a dollar rally and this will attract foreign capital keeping interest rates low.  Think about it for a moment, if the United States was seen to be balancing its budget and thereby taking care of its debt issues it would be viewed in a positive light as a good place to invest for safety.  A dollar rally would also take the lid off much of the inflation drivers as oil and other commodity prices would fall.  So if inflation remains muted and the currency remains strong there is every chance that interest rates will remain low for an extended period.  Furthermore I would argue that if interest rates on the 10-year Treasury rose to say 4% that there would be an enormous demand for the product as that rate combined with a strengthening currency cannot be found anywhere.  For a while it was available by investing in Australia and their economy boomed during this period, however it has since faded with the problems in China.  That said it is a model that can be shown to work and one that I would expect Romney to hang his hat on.

So what are the chances that he gets elected?  Well based on some of my sources it seems that the probability is relatively high.  With unemployment stubbornly high and spiralling government debt it appears that most people want a change to see if that helps.  In looking at the market one thing that it does not like is uncertainty and the coming election is creating uncertainty and this is showing up in the slow roll over in the indices.  It is pointing toward a hard hit if Romney is elected but to me the interest factor is to see how interest rates react as if they do not spike on a Romney win then there is a better chance that he can pull off a continued low interest rate environment while implementing his policies.

The last criteria would be the longer term.  I believe that while the market may sell off sharply in the near term on his announcement it is always hard to believe a politician until his actions start to match his words.  Will Romney bow to congress once president and change his policies to suite them and will there be a congress that supports his measures if they get too tough to swallow.  One thing is for sure, creating jobs by cutting the deficit, while it sounds good and will work in the long run, is sure to create short term pain and if I know anything about politicians it is that short term pain always wins over long term gains!