The Election That Really Matters

10/05/2010 10:15 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Sure, the US election could lead to political gridlock in Washington, but the vote that could most affect your portfolio hasn't even been scheduled yet.

It's election season.

No, no. I don't mean just in the United States. You don't need me to point out that your neighbor's lawn is festooned with "Vote for . . ." signs. Or that TV is plastered with "Don't vote for . . ." messages. Or that your inbox is full of "Contribute to . . ." appeals.

But the United States is just one of many countries holding elections in the next month or so. If you include formal elections (Brazil and the United States), formal non-election elections (China), and future elections in the making (Italy and France), almost two billion people are engaged in some kind of election activity now or will be soon.

Why is that important for you as an investor? Because, by and large, stock markets hate elections.

The Problem with Voting

Elections aren't predictable. They are hard to hedge, so investors and traders get stuck with a lot of the risk generated by that unpredictability. And, making the unpredictability and risk worse, elections can produce major changes in policy that can change the profitability of industries, and, in the worst cases, investing in general.

All that means elections make stock markets nervous. That, in turn, can create big moves on little or no real information and intensify normal fluctuations in market sentiment. It's a good idea to pay attention so you can separate the market moves you need to watch from those you don't—and flag those overreactions that might be buying or selling opportunities.

In a moment, I'll get to a list of elections, near elections, and potential elections over the next month that I think could move stocks.

But first let me use the recently concluded Brazilian voting to illustrate how even an election that's relatively simple to project can make investors nervous.

Will Dilma Live Up to Lula?

On October 3, Brazil voted for a new president to succeed Luiz Inácio Lula da Silva, who was barred by the country's constitution from running for a third term. There's never been much doubt that Dilma Rousseff—known in Brazil as Dilma, just as the president is known to every Brazilian as Lula—would win the election. She is Lula's anointed successor, and she's seen as a relatively colorless but efficient administrator who would carry on Lula's policies—no small advantage when the president has an 80% approval rating.

But while Dilma has never trailed in the polls, in the days running up to the election, the race tightened enough to throw into doubt her ability to avoid a runoff by grabbing more than 50% of the vote. According to a poll published September 28, Dilma had a 16-percentage-point lead over her biggest rival, José Serra. But that put her at just 46%, and it was down five percentage points from her numbers two weeks earlier and three percentage points down from a week earlier.

Most of that loss in the polls went not to Serra but to the third candidate in the race, Marina Silva of the Green Party. On September 29, she had climbed to 14% in the polls, up from 9% a month earlier.

Not much for investors to worry about here, right? A candidate who has pledged to continue the policies of a wildly popular president is far in the lead. Her closest opponent is showing no signs of picking up ground. The worst that could happen is a runoff that she is certain to win.

And yet the market got noticeably nervous. Volume for the iShares MSCI Brazil Index (NYSE: EWZ) exchange traded fund and for individual stocks such as Vale (NYSE: VALE) and Itaú Unibanco (NYSE: ITUB) slipped on pre-election news Thursday and Friday (though the prices didn't move significantly downward, I should note).

Investment bankers gave interviews saying the election wouldn't affect their plans to raise big money in stock and bond offerings for their Brazilian clients. Fund managers on road shows to raise huge amounts of money to invest in Brazil chanted the "no issue" mantra, too.

But somewhere in the background, everybody remembered 2006 when, shockingly, Lula was forced into a runoff in his bid for re-election after receiving just 48% of the vote.

And in fact, Dilma apparently didn't get enough votes to avoid an October 31 runoff election against Serra, news reports say.

With this as a model, let's go on my tour of the world's elections, near elections, and elections to be. I've ranked the list in order of how big I think the effects could be, starting with the likely not-very-big ones and moving to the global-market-shifting ones.

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The United States

Right now, FiveThirtyEight blogger Nate Silver, who for my money is the best analyst of election trends, gives the Republicans a 65% chance of taking control of the US House of Representatives with a relatively small majority of 224 seats (a majority in the 435-seat House is 218). He puts the party's chance of gaining control of the Senate at 22%. That's up from 18% last week but still below the 26% peak before Christine O'Donnell won the Republican nomination in Delaware.

If Silver's read is correct, the US will come out of the election with more political gridlock. Neither party would be able to move any part of its legislative agenda. The Republicans have promised to launch investigation after investigation of the Obama administration if they gain control of either house of Congress, and I don't see any reason to doubt that promise. Gridlock would kick solutions to Social Security's and Medicare's pressing budget problems down the road and leave the US budget deficit intact.

That probably wouldn't sit well with the overseas investors who fund our deficits. Under that scenario, the US dollar would continue its decline. US voters have frequently expressed their preference for divided government, but for investors, the big question is, "What does Wall Street expect from this election?" In 2008, Wall Street gave more to Democrats than to Republicans ($90 million to $68 million), according to the Center for Responsive Politics, reversing its historical preference. This year, the Street has apparently swung back sharply to the Republican side. Would all that money be satisfied with gridlock or disappointed at not being able to roll back the limited legislative changes of the past two years?

The mood on Wall Street gets played out in everything from analyst opinions to portfolio allocations. A disappointed Wall Street would, in the short run, be a negative for US stocks—and quite probably a positive for overseas assets.

China

China's Communist Party will hold its annual meeting October 15-18. The party will decide on the country's next five-year economic plan and is expected to make appointments that will further mark the elevation of Xi Jinping to replace the team of President Hu Jintao and Prime Minister Wen Jiabao when they retire in two years. Xi is expected to get a seat on the Central Military Commission at this year's meeting. That would punch the military card that China's leaders are required to carry.

This "election" could have two potentially disruptive results:

  • First, Xi could fail to get the post. Many observers of China's leadership had expected that he would get the post last year. That could indicate some uncertainty or division among the country's leadership.
  • Second, disagreements about economic and political reform could emerge into the open at the meeting. (Keep in mind that I'm talking about "into the open" in a Chinese context.) That could mark unsettling uncertainty about the country's direction. And China's investors, who gamble on every change in government policy, would be left guessing on that policy.

NEXT: The World's Most Crucial Upcoming Election

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Italy and France

Although these countries don't face scheduled elections this year, domestic politics there are pushing the governments toward earlier-than-expected elections. Call these potential elections. The effect could be to create an entirely new level of worry about the euro.

In Italy, the coalition government of Silvio Berlusconi survived a no-confidence vote on September 29 by 342 votes to 275, but the odds are still that Berlusconi will be forced to call early elections, most probably next spring. (The government's term runs until 2013.)

It certainly didn't help that in the days running up to the vote, Berlusconi ally Umberto Bossi, the head of the Northern League, called Romans "pigs." Bossi referred to the ancient Latin "SPQR" motto of Rome that dates from the days of the Roman Empire, saying that it stood for Sono Porci Questi Romani (These Romans Are Pigs) rather than Senatus Populus Que Romanus (The Senate and Roman People).

The fall of the Berlusconi government would have more effects on financial markets than Italian politics usually do because it would come at a time when investors were worried about the ability of Europe's most indebted economies to balance their budgets. Italy faces a huge budget deficit, and its economy is increasingly uncompetitive in the global economy. Anything that focuses attention on the inability of any Italian government to fix the country's problems won't reassure investors.

But the political situation in France has even more potential to move markets to the downside. Approval ratings for President Nicolas Sarkozy have moved to an all-time low, with 72% of respondents in a recent poll saying they do not trust Sarkozy to solve France's problems. That's a drop of five percentage points in a month.

The president's standing is falling fastest among older voters, who had been among his strongest supporters. Polls say 60% of the people over 65 don't have confidence in the president. That's an increase in his unfavorable numbers of seven percentage points from the previous poll.

Although Sarkozy's recent hard shift to the right on issues such as immigration have cost him points in the polls with his party's moderately conservative base, the big drop among older voters is connected to his pension reform proposal, which would raise the retirement age to 62 from 60 by 2018. If very modest change like that isn't politically possible in France, the country stands no chance of closing its current official budget deficit of 7.7% of gross domestic product. The government has announced a plan to reduce the deficit to 6% in 2011 and 3% by 2013. That would finally get France back within European Union budget deficit guidelines.

If Sarkozy can't get his plan passed and the current government is forced to hold elections ahead of schedule in 2012, investors will rightly ask whether this plan is worth even a centime. Now, it's one thing for Italy to run a big deficit; Italy always runs a big deficit. But for France to show no sign of being able to get its budget in order is a totally different matter. This wouldn't be a problem in Greece or Ireland or some other country at the edge of the euro zone. This would be a problem in one of the two countries (Germany being the other) that are the heart of the euro. (For more on the euro's problems in the periphery, see my post "Now It's Ireland's Turn to Rattle the Euro.")

That's why the potential election in France gets my vote for the most important in this extended election season.

At the time of publication, Jim Jubak did not own shares of any company mentioned in this column in his personal portfolio. His new mutual fund, Jubak Global Equity (JUBAX), may hold positions in the companies, and positions may change at any time.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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