NEW YORK -- Partisan politicians. Divisive politics. Fights about economic policies. Financial markets have been battling political headwinds ever since Republicans won control of the House of Representatives in last year's midterm elections.
Get used to it.
A year from now, the White House and Congress will again be up for grabs. Election Day isn't until Nov. 6, 2012. But Wall Street is already bracing for more turmoil caused by Capitol Hill. And the potential for political risk is already on investors' radar.
"The political backdrop in the United States will be notably toxic for the financial markets next year," says Joe Quinlan, chief market strategist at U.S. Trust.
Political gridlock, normally a good thing for markets as investors figure damaging legislation is unlikely to get passed when power is balanced, has morphed into a roadblock.
Quinlan expects corporations, investors and consumers to "tread cautiously" in the first half of the year due to all the negativity about the nation's economy and finances that will surface during the campaign. The negativity, he warns, could dent confidence and cause stocks to stagnate for most of 2012 before rebounding later in the year when investors get a handle on the likely outcome of the election.
Republicans and Democrats are so far apart on key issues, such as taxes, deficit reduction, job creation, health care and business regulation, that investors fear big decisions that need to be made to fix things won't be made. Republicans blame President Obama and the Democrats for stifling the economy with too many regulations, too much spending and too many growth-choking policy prescriptions, such as raising taxes on businesses and the wealthy. Democrats blame the Republicans for catering to Wall Street and for their unwillingness to compromise.
As a result of this friction, some investors fear nothing will get done in the next 12 months.
"We are in a stalemate," says Nicholas Olesen, a private wealth manager at The Philadelphia Group. "We don't think anything will pass until after the election."
The ongoing stalemate is a cause for concern. The grim memories of the big hit to confidence in the USA that occurred this summer during the nasty debt-ceiling fight are still fresh in the minds of Americans. That inability to compromise ended badly. In early August, major rating agency Standard & Poor's, citing politicians' inability to work together, downgraded the nation's triple-A credit rating, causing stocks to plummet.
Meeting of minds
The next test to see if lawmakers can work together comes on Nov. 23. That's the deadline for the Congressional "supercommittee" to come up with a plan to trim the nation's deficit by $1.2 trillion to $1.5 trillion in the next decade. Democrats have been pushing for spending cuts and tax increases. But the GOP is balking at any tax increases, arguing that they would harm an already fragile economy.
"That's the first speed bump," says Andy Busch, a public policy strategist at BMO Capital. "It is extraordinarily important. If it doesn't happen now, it will never happen."
In the upcoming election, Busch says, investors will be looking to elect lawmakers who view the economy through the prism of a corporate CEO.
"We need politicians and policies that will put the country on a proper path to growth," Busch says. "People are looking for leaders that understand the nuts and bolts of what makes an economy and company grow and what creates jobs."
Olesen says all the uncertainty about who will win, what policies will be enacted in 2013 and how markets will react won't be cleared up until late next year, when investors get more clarity on whether Obama will be re-elected or a Republican will topple him.
Oddly, either outcome could be bullish for markets, argues Ken Fisher, founder and CEO of Fisher Investments.
"After elections, we end up feeling better," Fisher says. "We always end up with a winner. If voters fall in love with the GOP candidate, they will have the kind of hope that people had for Obama in 2008. And if they don't fall in love with the Republican, they will decide that Obama is not as bad as he was yesterday."
History backs up Fisher's bullishness. Stocks have posted average annual gains of nearly 15% when a Democrat is re-elected president, and nearly 19% when a Republican is newly elected.
'At an inflection point'
The 2012 election season comes at a pivotal time for the nation, which is still badly shaken by an economy in the doldrums, too few jobs, too much debt and a level of economic discontent on Main Street not seen since the Great Depression.
A grassroots revolution is underway on Main Street. The Occupy Wall Street movement is spreading nationwide amid rising dissatisfaction with the declining standard of living for the middle class. The protestors rail against economic inequality and blame a political system corrupted by Corporate America's deep pockets.
"We're at an inflection point," says Mark Luschini, chief investment strategist at Janney Montgomery Scott. "Much of what happens after the election will depend on who is in office. The market would react favorably to regulatory relief, tax reform and meaningful fiscal responsibility. It is not so much the party as it is clarity to the rules of engagement. If we have an administration that pushes for more regulation and fiscal spending, returns will suffer."
The big issue is getting the economy humming again, just as it was in 1992 when Bill Clinton beat George H.W. Bush with the help of the campaign slogan, "It's the economy, stupid!" This time, "it's gonna be all about jobs," says Mike Ryan, chief investment strategist at UBS Wealth Management Americas, acknowledging the nations' 9.1% unemployment rate.
Another buzzword will be "growth," Ryan adds. Wall Street, he says, will try to sniff out the candidates with the best policies and plans to jump-start the economy, trim the nation's mounting deficits and revive risk-taking. "Whose path is the better path? Whose plan is best for jobs? It will be all about policy," Ryan says.
Despite posting a 2.5% growth rate in the just-ended third quarter, the U.S. economy has slowed considerably in 2011 vs. a year ago when growth was between 3% and 4%. The economy has been unable to grow fast enough to lower the unemployment rate, which poses a problem for Obama. No sitting president has won re-election in the post-war era when the unemployment rate was rising in an election year, Strategas Research Partners says. To further complicate matters for Obama, there is a growing perception on Wall Street and in CEO corner offices that the president and his policies are anti-business.
Some Wall Street analysts say the election outcome could be determined by how the economy and markets fare in the months leading up to the 2012 vote. "If the economy is recovering in a meaningful way, Obama will probably have a second term," predicts Byron Wien, vice chairman of Blackstone Advisory Partners. "If the economy is still weak and unemployment is still 9%, he won't. The economy is what's on the mind of the average voter."
Historically, the fourth year of a presidential cycle has been bullish for stocks, with the Standard & Poor's 500 index posting average gains of 5.7%, S&P data going back to 1944 show. Year three is best for stocks, while the first two years of the presidential cycle are the least profitable. Currently, the GOP controls the House, and Democrats control the Senate and the White House.
Next year's election also comes amid a growing backlash against elected leaders in Congress. The political dysfunction has sparked a bull market in uncertainty.
That uncertainty has caused corporations, small businesses and Main Street consumers to hunker down, which has hurt growth. Companies in the S&P 500 are hoarding cash rather than deploying it to hire new workers or fund fresh growth opportunities. Small businesses, unsure of what their future costs for health insurance and taxes will be, are holding off hiring, too. Consumers are putting off big purchases because of job insecurity.
Jim Paulsen, chief investment strategist at Wells Capital Management, says this has caused a lack of "forecasting clarity," which has hurt the market. But the problem may be resolved by the election. How? If a Republican wins the White House, or to a lesser degree, if Obama is re-elected but the GOP gains even more seats and clout in Congress, it will be perceived as "market friendly," he says.
Under pro-business Republican leadership, Paulsen says, the "pace of change" will slow when it comes to new policies, social programs, regulatory changes and tax reform. And that will prove bullish, as it will "promote greater confidence in a more predictable future," says Paulsen. "The markets need stability, and a move to the political middle would be the best political outcome."
Historically, less legislation translates into higher stock prices, Fisher adds. Stocks fare better in the third and fourth years of a president's term because the threat of major legislation is less likely.
There is a perception among investors that stocks fare better with a Republican president or when Republicans control Congress. Republicans have a reputation for being business-friendly and favoring growth-oriented policies such as low taxes. Past performance backs up the theory. The best average annual gains (9.6%) have occurred with a Democratic president and a Republican Congress, Ned Davis Research says. The second best (+7%) came when Republicans controlled the White House and Congress.
If the GOP retakes the Senate while maintaining its edge in the House, history says stocks have a good chance of rising no matter who is president.