Regular readers of "A Dash" know that I spent the early part of my career teaching public policy to a wide range of students -- undergraduates, PhD candidates, and career professionals seeking the MPA degree. The effect of elections on future policy direction was a staple of these courses.
When I became a consultant to trading firms, and later an investment manager, the analysis of changes in policy helped give us an edge in finding the best stock sectors. The key to being a good consultant and advisor is easy to state and very difficult to follow:
- Put your personal opinions aside;
- Analyze what will happen -- at least in terms of probabilities;
- Analyze the likely consequences; and finally
- Look for stocks that will benefit.
Many of the popular investment sources are so focused on their own opinions that the investment angle is lost. Here at "A Dash" we urge political agnosticism -- you should seek to profit in your investments no matter who is in power.
With that in mind, here is how we see the election.
The Prognosis
I watch the regular sources, but also some that do not get much play in financial media. There is a general agreement that the GOP will take control of the House and make major gains in the Senate, falling short of a majority. There are plenty of pollsters. Some are retained by news organizations and some by each party. In my own forecasting, here are the sources I rate most highly:
- University of Virginia Prof Larry J. Sabato. His "Crystal Ball" site has been the most accurate source of forecasts for many years. For some reason, it has not gotten the visibility in the investment community. I love the "bottoms-up" approach, emphasizing careful analysis of each race. Sabato was the first to predict a big GOP result. His forecast has not changed very much. It is close to the consensus, but he was there first. You can see the details here. He sees a GOP pickup of 55 House votes and 8 in the Senate.
- The Hill. They did a special poll focusing on the key districts. This eliminates a lot of what is basically irrelevant. You can see there results here.
- FiveThirtyEight does a great job. I like this site because it proves that a disciplined approach to research methods leads to good results. If you can do it with baseball, you can do it with elections. The methods are the same. Are there other issues? Probably, but it is an open field on interpretation. Here is the final projection.
- The Intrade markets are especially interesting. This site represents a "wisdom of crowds" synthesis of all of the other information. The questions reflect the number of seats to switch in the House as well as control of the Senate. Take a look. The prediction markets predict a slightly better picture for the GOP in the Senate.
Anyone who follows these sources will have a significant information advantage over the average investor.
What to Watch
Drawing upon the various sources, what should investors be looking for tomorrow night? The crucial question is whether the GOP can gain control of the Senate. The sources all see the GOP coming up a vote or two short. Could the GOP result be better? Professor Sabato tells you which races to follow:
We believe the GOP will hold all its open seats (FL, KY, MO, NH, OH). This is quite an accomplishment in itself, since the early assumption was that at least a couple would switch sides. In addition, Republicans will probably pick up most of the following: AR, CO, IL, IN, NV, ND, PA, and WI. The closest appear to be CO, IL, NV, and PA. These races, especially the first three, are so tight that a strong breeze could change the result, so the GOP may well come up one or two short in this category. By the way, if Republicans do win the +8 we have projected, then they only have to unexpectedly pick off two of the following states to take control: CA, CT, WA, or WV. CT seems least likely, WA most likely–but any of the foursome would be an upset.
The Perception
There have been many stories suggesting that "Gridlock is good" or "Gridlock is less profitable than control." Many of these prey upon a general anti-politican feeling. Let us hope to immobilize Washington!
In fact, the situation is quite different. The country needs some cooperation so that the Bush era tax cuts do not expire, and the inheritance tax is re-established at a reasonable level. Gridlock would not be good for the economy or the budget deficit.
The general perception is simplistic and incorrect.
The Reality
Here are the key elements of reality.
There will be no major legislative changes, especially no repeal of health care reform. This is really pretty simple. The US political process has a huge status quo bias. With Obama Care now a matter of political reality, the provisions are not easily changed. The President can veto any effort at repeal.
We can expect a GOP House to pass repeal measures, but that will simply be a political gesture without effect.
The real consequences of GOP control are important, but more subtle.
First, there is the power to control House committees. This means that the GOP will control committee staff, be able to launch investigations, and be able to issue subpeonas. This is really important, since it can keep Administration appointees on the defensive. Here is a list of the Obama officials most worried about a GOP takeover of the House.
The Effect
The most important effect will be two years of negotiation and compromise. I would like to be more specific, but this is a story that will play out over time. There are many variables, including how the GOP will react to the new "tea party" representaion.
I will make two "fearless forecasts."
First, I predict significant legislative compromise.
There is bipartisan interest in fixing the tax problems. The Bush-era cuts will be extended and the inheritance tax modified.
Most people do not realize how GOP opposition shaped the Obama legislation. Sixty votes were needed in the Senate, and compromise weighed heavily on getting the last two votes. This is still in play.
Second, I see a new emphasis on Congressional oversight. Policies that are already a matter of law, like health care, still require specific regulatory language. Most people do not realize this, but it is an important part of the process.
Investment Implications
This is not a story requiring an immediate reaction on election night, partly because it has been anticipated by the market. If it plays out as I suggest here, there is plenty of time to profit.
My initial ideas relate to health care (less restrictive in regulations, more profitablity for health sector firms), financials (less aggressive regulatory treatment), and drillers (easier rules).
Since the implications are not obvious to most, there is still plenty of time to buy.
[Full disclosure: We own GS, NE, and WLP. We are shopping for other names in these sectors.]
