Editor's Note

01/10/2008 12:00 am EST

Focus: MARKETS

Howard Gold

Founder & President, GoldenEgg Investing

January 10, 2008

It's crunch time for the markets and the economy.

As fear of a US recession grows-this week Goldman Sachs predicted one would occur in 2008-more technicians are talking about a bear market and even some longtime bulls are throwing in the towel.

The major averages have fallen precariously close to what technical analysts call support levels.

On Wednesday, January 9th, the Dow Jones Industrial Average hit an intraday low of 12,431.53. That's a hair below the 12,455.92 it hit on August 16th, just before the Federal Reserve cut the discount rate for the first time.

Also on Wednesday, the Standard & Poor's 500's intraday low was a mere eight points above the 1370.60 it hit on August 16th.

Mark Leibovit of VRTrader.com says Wednesday's big rally on massive volume indicates "a double-bottom formed in the major stock market indexes."

But he cautions that "holding those lows (approximately 12,500 in the Dow Industrials and 1370 in the S&P 500) on a closing basis would be the defining moment for the bull market."

Other technicians agree, give or take a few points. And though I'm holding my breath and crossing my fingers that the market won't fall much further, I'm not ready to revoke my long-time prediction (repeated here last week) that stocks will move higher. If the averages fall sharply through those support levels, though, I'll have to reconsider.

But while everyone is blaming the markets' problems on the subprime crisis, the credit crunch, and the looming shadow of recession, people may be overlooking one obvious cause of the recent jitters: the presidential election.

Now this column is not about politics, and I'm pretty skeptical of analysts who try to link the markets' moves with the ebb and flow of political sentiment.

But consider this: the Dow lost nearly 1,000 points and the S&P more than 100 since December 26th, when media coverage began focusing intently on the campaign and upstarts Senator Barack Obama and former Governor Mike Huckabee were surging in the polls. Both, of course, won the Iowa caucuses.

And I think it was no coincidence the markets rallied strongly on the day after Senators Hillary Clinton and John McCain achieved come-from-behind victories in the New Hampshire primary.  Call it, perhaps, the "grown-ups' bounce."

Does that mean investors are backing Hillary and McCain? Hardly, although the junior senator from New York has raised big sums from Wall Street and counts John Mack, chief executive officer of Morgan Stanley, among her most prominent backers.

But it does mean that this year in particular, investors are as likely to pay as close attention to the electoral calendar as they do to the economic one.

Here's why. First, as we all know, this election is "front-loaded": Nearly 30 states will have had presidential primaries or caucuses by February 5th. That could put at least one of the candidates in the driver's seat by then.

But if no clear winner emerges, it could leave things up in the air through March, April, possibly even to the conventions, which begin in late August. Nature abhors a vacuum, and so do investors.

Second, this is the first pure "up for grabs" election (in which neither of the nominees is president or vice president) since General Dwight Eisenhower defeated Governor Adlai Stevenson in 1952. It thus opens the door for sweeping change, clearly the big theme this year.

Indeed, the stock market tends to do worse in years in which incumbents aren't running than in years when a president is seeking reelection.

As I wrote here (subscription required) in 2004, the five elections since World War II in which an incumbent wasn't running (1952, 1960, 1968, 1988, and 2000) produced annual average returns of a mere 3.7% for the S&P 500. That's well below the double-digit gains the S&P generally registers when a sitting president is in the race.

This year investors are particularly nervous because economically a lot is at stake. All the major Republican candidates (except for Gov. Huckabee) call for making President Bush's tax cuts permanent, while  the major Democratic candidates want to repeal them for households earning more than $200-250,000 a year.

Most of the Republicans also want to eliminate the estate tax while the Democratic candidates want to preserve it. Republicans also would generally keep long-term capital gains tax rates at 15%, while Senators Obama and John Edwards favor raising them to as high as 28%. (Senator Clinton voted to keep those cuts.)

And except for Senator McCain, none of the major candidates has made cutting spending a big issue, as the Wall Street Journal reported last week (subscription required), and the Democrats' ambitious health care plans would likely make the budget deficit worse, not better.

The US dollar has fallen dramatically over the last few years largely because of concerns about the budget and current account deficits. Those deficits have been shrinking of late, but investors want to keep things moving in the right direction. Their unspoken fear: that we will have a "frame-breaking" election in which Democrats win the White House and comfortable voting majorities in the Senate and House of Representatives.

Finally, as I observed last week: "If [the candidates] adopt strong populist messages and it resonates with voters, then higher taxes and trade and immigration restrictions may be in the cards. That would not be good for the markets."

We saw glimpses of that in New Hampshire Tuesday night when Senator Clinton railed against "the oil companies, the drug companies, the health insurance companies, [and] the predatory student loan companies." 

Even Senator "Can't-We-All-Get-Along" Obama said, "we can tell the drug and insurance industry that, while they get a seat at the table, they don't get to buy every chair, not this time, not now." And this campaign is just getting started.

That's why investors need to keep one eye on the political calendar this year. And by the way, during the last free-for-all election in 1952, the S&P rose 11.8%.

As I said, I'm nervous but still bullish.

Howard R. Gold is executive editor of MoneyShow.com. The views expressed here are his own and are not necessarily the opinions of InterShow.

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