Stocks and Politics
David R. Kotok
Cumberland, February 22, 2016
“Stocks have struggled during the first half of election years. The DJIA has bottomed in May of election years, on average, but the timing has become linked to when the winner has been clear. For example, in 1996, President Clinton’s reelection bid was rarely in doubt, and the DJIA suffered only one correction over 5%. Conversely, in 2004, George W. Bush was in a tight battle with John Kerry for a second term, and the market didn’t make its low of the year until 10/25. A narrowing of the presidential field could reduce the political uncertainty and provide a lift for stocks.”
Source: Ned Davis Research Group, Issue #SSF16_03. For those who are subscribers to Ned Davis data and services, you may wish to consult chart S01642. For details, go to www.ndr.com.
True to form, markets have started this presidential election year cycle with high downside volatility. The Ned Davis database has tracked the details and progression of every presidential cycle for over a century, using daily data. The history is clear. The political outcome will certainly be clarified, since the process is driven by a fixed calendar. As clarity emerges, the stock market will begin to discount the outcome. Regardless of who the victor is, markets are likely to rise, and the upward trend is likely to continue to accelerate from the point where the clarity begins to appear to well into the victor’s first presidential year.
Some bullets follow.
1. We are now down to seven: Carson, Clinton, Cruz, Kasich, Rubio, Sanders, and Trump. (We are purposefully following alphabetical order.) In addition, Bloomberg may jump in as an independent candidate. He is a known unknown. The other seven are now well known, and the outcomes for both major parties are becoming less uncertain. The list is morphing from intense uncertainty to tentative clarity as leaders emerge and stragglers fade.
2. Hillary Clinton seems more likely than Bernie Sanders to become the victorious Democrat by amassing sufficient delegates to achieve a pre-convention win. Thus a deadlocked or brokered Democratic convention is increasingly unlikely. This is a shift from uncertainty toward clarity.
3. The Republicans face a convention that will possibly require more than a single ballot to select the nominee. So the uncertainty premium with respect to the Republicans remains. However, Trump’s successes have clearly placed him in a position to be seriously considered.
4. Michael Bloomberg’s entry into the race as a third-party candidate would change the picture – but only with regard to the general election and not the outcome of the two conventions. History is not kind to third-party candidacies. Examine the campaigns of Henry Wallace, John Anderson, or Ross Perot for guidance. A harder question is whether a Bloomberg run would hurt the Democratic candidate more than it would the Republican or vice-versa. Bloomberg’s entry would add to the uncertainty premium for this reason.
5. Markets seem to ascribe little uncertainty risk to a deadlocked Electoral College. But a three-way race could trigger uncertainty risk if the third-party challenger became likely to win one or more states. Remember, Bloomberg might not be the only third-party challenger. It is possible that Sanders could launch an independent run if the March 1 outcomes place him so far behind Hilary Clinton that he either has to drop out or alter his affiliation and run independently. Likewise, Trump has the resources to run as an independent if the Republican establishment is able to orchestrate the convention outcome so that he is denied the nomination. Imagine the brawl if there are still five candidates in November: Bloomberg, Sanders, and Trump as third-party entries; Hillary Clinton for the Democrats; and Rubio or Cruz for the Republicans. Now THAT would be entertainment.
6. The US Constitution sets forth the mechanism to be followed if the Electoral College is deadlocked. It was articulated in 1804 in the Twelfth Amendment. The House of Representatives would determine the presidential outcome from the top three vote-getters in the Electoral College. Note that the vote is by state. So a state like California, with many electors, and a state like Maine, with few electors, will be equally weighted if there is an electoral deadlock. Convergex notes that American history saw such an event in the election of 1824 (hat tip to Nick Colas and Jessica Rabin for detailed research into American history). Andrew Jackson got 41% of the vote and didn’t become president. In the House, Speaker Henry Clay brokered a deal, and that is how John Quincy Adams became president even though he got only 31% of the vote. Note that the Senate picks the vice-president from the two remaining highest Electoral College vote getters. Thus it is possible that the president and vice-president might be appointed from opposing political parties.
7. There have been a number of amendments to the Constitution since 1804, and they open up questions. They are the Fourteenth, which describes who may be an elector; the Fifteenth and Nineteenth, which protect voting rights; the Twenty-Third, which adds electors from the District of Columbia; and the Twenty-Fourth, which protects voters from the levying of poll taxes. Note the general theme of all of these amendments is to protect the citizen’s voting franchise. That leads to another question about the House of Representatives and its non-voting member from Puerto Rico. Would his non-voting status apply in a deadlocked Electoral College vote in the House? Puerto Rico is populated by more than three million American citizens. Their elected representative does not vote on House legislative matters, but the issue of a presidential selection has never been tested.
8. There is one additional – and extremely remote – possibility. The referee of any constitutional issue regarding presidential elections is the US Supreme Court. We saw the Court come into play in the 2000 election dispute that centered on those notorious hanging chads. A Supreme Court decision was required to determine the outcome of the presidential election.
9. But we know the Supreme Court could still be functioning with only eight justices in November. What would happen if they divided four to four in an election dispute?
Dear readers: The last four items in this list are highly speculative and only remotely likely. But they are possible. If any of them becomes more likely, the markets are apt to react negatively because uncertainty premia will rise. More likely, the presidential election process will be clarified in the coming months, and markets will start to discount the winner. The same will be true of the outcomes of US Senate races. The House is likely to remain in Republican control. Note that in a quirk of the calendar, a change in the US Senate to a Democratic majority could open a brief window wherein the new Senate could alter the filibuster rule and then confirm a Supreme Court appointment by outgoing President Obama. Were that to happen, it would occur in the final two or three days of Obama’s term in office.
In sum, political uncertainty is high. Markets have reflected an uncertainty premium since the beginning of the year. The clock is running, and the calendar will force more clarity. We believe clarity will add to the upward movement of stock prices. History is clearly on the side of this view. We remain nearly fully invested in our US stock market ETF accounts.
March 1 will be an important day. The mix of primary elections and caucuses on that day may resolve the electoral situation in thirteen states. Some state results will be pivotal for the Republicans, some for the Democrats, and some for both. When we awaken on March 2, the uncertainty premium may be higher and the risk of deadlock greater – or clarity may be obtained. We will know soon.
Meanwhile, the outlook remains positive, as American tradition usually prevails. At least it has since 1824.
David R. Kotok, Chairman and Chief Investment Officer, Cumberland