For Economic Clues, Watch Congress

11/06/2012 9:15 am EST


Jim Jubak

Founder and Editor,

Tuesday's results will shape year-end battles and the road for investors in 2013. But the presidential race may be less important that what happens to the House and Senate, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

On Wednesday morning, the global financial markets will breathe a big sigh of relief—if the United States has actually elected a president.

Barack Obama? Mitt Romney? It doesn't matter from this perspective and in this time frame. It's good news if the election isn't headed to the Supreme Court or the House of Representatives.

A clear-cut decision, accepted by all sides, is better by far than any of the frightening outcomes making the rounds of Wall Street trading desks in the days before the election. Headlines about voter suppression in Florida and Ohio, and dirty tricks in Virginia and Pennsylvania, certainly make some on Wall Street worry that whoever wins, the other side won't accept the result.

You think an election that sends Speaker of the House John Boehner to the White House as president with Joe Biden as vice president would produce enough chaos to send the indexes tumbling? (It could happen, if a tie in the Electoral College sends the decision to the House.)

Yet if we get an unchallenged decision (no matter how much grumbling), we'd better enjoy that sigh of relief while it lasts. The campaign for 2016 starts almost immediately, with all the jockeying for advantage that goes with it. I'd give us ten days, maybe two weeks, without campaigning.

And that, like it or not, will be the background as the politicians in Washington begin to confront the fiscal cliff of expiring tax cuts and mandatory budget cuts that threaten to end the current weak recovery, and to send the US economy—and much of the global economy—back into recession.

For clues on how that longer battle will turn out, keep your eyes on Congress on Tuesday night.

Preparing for Battles Ahead
Will politicians try to use fiscal cliff to advance their own electoral agendas? You bet.

Will politicians restrain their posturing out of a fear that they might talk the economy back into recession? Not a chance.

Will politicians take the country close to the brink in order to extract maximum partisan benefit? Does the sun rise in the east?

Will some politicians be willing to take the country over the cliff in order to win what they deem to be a long-term political advantage? Absolutely.

What you want to know as an investor isn't whether there will be politically motivated fiscal-cliff noise and chaos—because, of course, there will be. What you'd like to know instead is how much noise and chaos to expect.

Are we looking at events that will form a worrisome background that might amplify fear in the market but won't necessarily make up a determining downward trend? Or are we looking at such loud and disruptive chaos that it will make every other trend in US (and potentially other) financial markets secondary to relentless downward pressure?

I'll bet you'd like to know. I'd sure like to know. And I think I've come up with some clues for figuring out how deadly a witches' brew of US politics and fiscal crisis we're likely to see in the coming months.

My basic advice is to pay more attention to the races for Congress, and especially the House of Representatives, than to the presidential results. What will really matter in the coming months is how much fear and triumphalism the elections produced among the Republican and Democratic members of Congress.

How they read the result will determine how they behave in the negotiations over the fiscal cliff—so we investors had better spend a little time figuring how these politicians interpret November 6.

Key to figuring that out is knowing not only who won and lost, but also what their parties are likely to make of those victories and defeats. In the days after the elections, the parties will develop their own narratives to explain the results, and those narratives will go a long way to determining how the two parties will behave in the campaign for 2016 that starts all too soon.


First, the Donkeys
Let's start with the Democratic side, since it's relatively simple.

If the Democrats lose the White House, they could well lose the Senate, too. If not, the Democratic Party in the Senate would be a shellshocked majority...unlikely, in my opinion to muster an effective filibuster strategy to stop a Republican White House and House.

The question, as I note below, would be how far an ascendant Paul Ryan wing of the Republican Party would be able to push the Romney administration toward an economic policy of tax cuts and cuts to discretionary spending. (More on this later, I promise.)

But what if Obama wins re-election and the Democrats hold on to (and maybe even increase) their majority in the Senate, while cutting a bit into the Republican majority in the House?

Before the election, more-aggressive members of the Democratic majority in the Senate were floating a strategy that would send the country off the fiscal cliff temporarily in January by allowing the Bush tax cuts to expire. That would mean that, technically, a vote in January for the Obama plan to raise taxes on the 1% while cutting taxes for the middle class would be a vote for a tax cut rather than a vote for a tax increase.

On the other hand, a vote to raise taxes in December on the 1% would be a tax hike. So the theory of these Democrats was that this would let some Republicans who had taken the no-tax-increase pledge of Grover Norquist and his Americans for Tax Reform group vote for the Obama tax plan without breaking their pledge (and risking political suicide when Norquist went against them in the next Republican primary.

How many Republican votes this would allow the Democrats to peel away would depend on who had lost seats in the election among Republicans. (Again, more on that later.)

I'm pretty sure that Wall Street and the debt-rating companies would not be amused by even a temporary plunge off the fiscal cliff. The exact extent of the damage would depend on how much faith investors put in Democratic promises to stop the plunge in midair and then reverse it by making everything retroactive.

Among the Elephants
A Republican victory that produced a Romney presidency, a reduced Democratic majority in the Senate, and a continued Republican majority in the House would probably be seen by conservatives and Tea Party Republicans as a vindication of their move of the party to the right.

Having run on (and survived) the Paul Ryan budget, a Romney administration would, in all probability, make that document its economic blueprint.

The effect on the fiscal cliff? Part of the cliff would vanish, since I think we can count on a Romney/Ryan administration to go whole-hog for renewing and extending the Bush tax cuts.

On the spending side, however, I think a Romney administration would be inclined to drive straight off the cliff. The Republican Party is committed to cuts in discretionary spending—even if it refused to spell them out in any detail during the campaign.

The conservative/Tea Party wing of the party, which would in effect be the Republican Party after a victory in this election, would pursue its agenda of shrinking the size of the federal government by cutting spending. What's up for grabs is the reaction of financial markets and debt-rating companies to this agenda.

The Ryan wing of the party has been adamant in its belief that the numbers in its economic plan add up—but they add up only if you accept the belief that cutting taxes and spending will accelerate the rate of economic growth by enough to increase government revenue despite the reduction in tax rates. That's the only way you can cut taxes by the amount that Romney and Ryan have proposed and also reduce the deficit.


The belief that government revenues will rise enough to cut the deficit even as tax rates are reduced—what's called "dynamic scoring"—isn't shared by all economists. My impression, in fact, is that there are relatively few believers in that scenario among economists on Wall Street and at Standard & Poor's, Moody's Investors Service, and Fitch Ratings, which means that a pure Ryan-plan approach to the fiscal cliff could get major push-back from the financial markets.

I don't know how a Republican plan to end the fiscal cliff that was given a less-than-passing grade by Wall Street and S&P nets out, but I'd be surprised if the ratings companies didn't at least warn of a potential downgrade of the US's AA credit rating.

This means there's a very real possibility of a collision between what I'll call Ryan Republicans and the credit-rating companies (and Wall Street), since the typical reaction by the Republican True Believers to criticism of dynamic scoring has been to ridicule the opposing viewpoint or simply ignore it (if they can't bury it, as they tried to do with a recent Congressional Research Service report that concluded that income tax and capital gains tax cuts wouldn't increase growth as much as Republicans have maintained). The financial markets aren't likely to simply shrug off threats to the US credit rating.

And what happens if Republicans lose the White House, fail to make any progress in taking back the Senate and see their majority erode in the House of Representatives? I can see two potential narratives.

First, the conservative/Tea Party wing blames the defeat on Romney's lack of seriously conservative credentials. The solution to defeat, then, is to move the party further to the right. In the context of the fiscal cliff, that would mean the party would dig in its heels on spending and tax cuts.

Some in the conservative/Tea Party wing believe so strongly that the future of the Republic hinges on cutting taxes and spending—and on reducing the size of the federal government—that they would be willing to pull a Thelma and Louise, and drive off a cliff rather than compromise.

Second, the more-pragmatic wing of the Republican Party—which has been shrinking in size and influence in the past two election cycles—blames the conservative/Tea Party wing for the Republican defeat on Tuesday. In this narrative, the extremism of conservative/Tea Party candidates alienated independent voters, and despite Romney's efforts to run back toward the center in the campaign's closing days, cost Republicans the election.

Tasting the Tea
I'd expect a tough battle between these two narratives if Republicans lose. The winning side will likely depend on which Republican candidates win and lose on Tuesday.

Conservative/Tea Party Republicans would argue that losses by Senate candidates such as Richard Mourdock in Indiana and incumbent Todd Akin in Missouri were due to extreme positions and verbal ineptitude more than to the candidates' fiscal policies.

That argument gets harder to make if Republicans lose in Virginia, Montana, North Dakota, and Wisconsin, but I'd expect that conservative/Tea Party Republicans will spin a narrative that says candidates such as Tommy Thompson of Wisconsin lost because they were insufficiently conservative.

That narrative will get harder to sustain if clearly conservative/Tea Party incumbents lose their races in the House of Representatives—or if conservative/Tea Party stalwarts shakily survive surprisingly tough challenges. Races to watch to see if candidates with conservative/Tea Party credentials lose and weaken the "We weren't conservative enough" narrative:

  • Arizona's 9th District, where Democrat Kyrsten Sinema faces Vernon Parker.
  • California's 3rd District, where incumbent Democrat John Garamendi faces a challenge from Kim Vann in a redrawn district.
  • California's 9th District, where incumbent Democrat Jerry McNerney faces off against Ricky Gill.
  • Connecticut's 5th District, where Democrat Elizabeth Esty faces Andrew Roraback.
  • Michigan's 1st District, where Tea Party favorite Dan Benishek's opponent, Gary McDowell, has tied him to Ryan's Medicare plans.
  • New York's 24th District, where Ann Marie Buerkle, a Tea Party Republican, faces a rematch with Dan Maffei.

Parker, Vann, Gill, and Roraback are all recruits of the “Young Gun” program designed to boost young conservatives to victory in House races.

Races to watch to see if they're close enough to scare conservative/Tea Party Republicans: Michelle Bachmann in Minnesota's 6th District, Allen West in Florida's 18th District, Steve King in Iowa's 4th District, and Roscoe Bartlett in Maryland's 6th District.

To the Winner Goes the Narrative
There's just about no chance that the House will switch hands in this election, but the narrative, win or lose, is up for grabs.

And although the election will be decided on Tuesday (probably), the battle over the narrative to explain the results will have just begun. And it's that story—the story that politicians will tell themselves to explain the results—that will provide the background for the politics of the fiscal cliff that will dominate the end of 2012 and the beginning of 2013.

For once, the political rhetoric will count. Listen carefully as politicians try to explain to themselves what happened on Tuesday.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio here.

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