By
Eric Parnell
:
It has been widely presumed that stocks will breathe a big sigh
of relief and surge higher once a compromise is reached on the U.S.
fiscal cliff and the overhang of uncertainty is removed from the
markets. But in the distorted post financial crisis environment,
political risk has proven to be most unpredictable. A look back on
some of the most prominent political episodes impacting financial
markets over the last few years shows exactly how.
The first and perhaps most memorable act of political theater in
the post financial crisis era came not long after the initial
outbreak. On September 19, 2008, a mere five days after Lehman
Brothers had declared bankruptcy, news emerged that fiscal policy
makers in Washington were actively working to craft a bailout
program for the U.S. financial system. Stocks were initially
ebullient on the news, soaring +8.5% higher on the S&P 500 (
SPY
) in two trading days on the news to levels that were
higher
than before the Lehman bankruptcy announcement. Over the next two
weeks, stocks held their ground valiantly. Although they crated by
nearly -9% on September 29, 2008, when the initial bailout
legislation failed to pass in the House of Representatives, they
quickly recovered much of this lost ground the very next trading
day on the notion that Congress would move quickly to successfully
pass a bill as soon as possible. And by October 3, 2008, when the
Emergency Economic Stabilization Act of 2008
was signed into law and the Troubled Asset Relief Program (TARP)
was ready to be enacted, stocks were still solidly holding their
ground at down just -4% since the collapse of Lehman.
It was only
after
TARP was approved by Congress and this political uncertainty was
removed that the stock market plunged lower. Over the next five
trading days
after
the law was signed, stocks fell by -27%. By late November 2008 they
were down as much as -35%.
(click to enlarge)
The second came a few months later. In a widely anticipated
speech that was supposed to outline exactly how the U.S. government
was going to carry out its new bank rescue plan, U.S. Treasury
Secretary Timothy Geithner took to the podium in Washington with
answers that only served to confuse investment markets and the
financial community even more.
It was only
after
Treasury Secretary Geithner revealed his plan that stocks plunged
violently. Over the next three weeks, stocks would lose over -23%
of their value.
(click to enlarge)
The third political event in the 2010 Mid-Term Elections was by
far the most subdued from a market reaction standpoint. It was
widely expected that Republicans would make strong gains in both
the Senate and House of Representatives on Election Day. And on
November 2, 2010, the GOP captured 63 seats in the House to reclaim
the majority and also tacked on 6 seats in the Senate. And although
stocks initially advanced by +3% in the first few days after the
election, this could widely be attributed to the Fed's official
announcement of QE2 the day after the election on November 3.
But even with the election uncertainty removed and the heavy
tailwind of a massive new balance sheet expanding stimulus program
from the U.S. Federal Reserve, stocks still managed to trend lower
through the remainder of November 2010
after
the elections.
(click to enlarge)
The fourth act of political drama for financial markets played
out during the summer of 2011 with the debt ceiling debate. Both
sides wrangled for months during the spring and early summer
months, yet the stock market teased with achieving new post crisis
highs. And even when the announcement came that an agreement had
been reached, the stock market was still trading well within its
trading range and not far from recent highs.
It was only
after
a debt ceiling deal had been struck that the stock market turned
sharply lower. By the middle of the next week, stocks had fallen by
-16% and appeared set to fall further if not for the Fed stepping
in with bold suggestions of more monetary stimulus coming soon.
(click to enlarge)
The most recent political uncertainty was resolved just recently
on November 6 with the Presidential election. Up until early
October, it was widely assumed based on polling data that President
Obama would retain the office. But following a decisive win by
Governor Romney in the first presidential debate, the outcome of
the election became more uncertain. And by Election Day, the race
was considered a dead heat in many polls. All along the way, stocks
continued to hover within just 2% of post crisis highs.
It was only
after
the election results were revealed and President Obama had won
re-election that stocks moved lower. Over the next eight trading
days, stocks lost -6% of their value.
(click to enlarge)
All of this leads us to the sixth act of post crisis political
uncertainty overhanging markets in the current U.S. fiscal cliff
debate. Although the outcome remains uncertain on a variety of
levels, stocks as shown in the chart above have stirred back to
life in rallying by +5% off of their recent lows and stand within
striking distance of post crisis highs.
Thus, history suggests that it would not be at all surprising to
see stocks head lower, not higher, following an agreement on the
fiscal cliff. Of course, it could play out differently this time
once a deal has been reached. More specifically, one key advantage
stocks have this time around is the fact that the Fed is already in
stimulus mode having launched QE3 back in September and is likely
to double down on balance sheet expansion with the announcement of
U.S. Treasury purchases in mid December. This is an enormous
tailwind for stocks. But even with this edge, the idea that stocks
will rally following a compromise deal on the U.S. fiscal cliff is
far from a foregone conclusion. To the contrary, it would not be
surprising to see stock markets move lower in the days following an
agreement, particularly if the deal appears unfavorable to the
financial markets and the business sector.
A final thought before closing. If stocks have shown the
propensity to move sharply lower once political risk has been
removed, does this suggest that stocks might actually rally if we
were to maintain this political risk and simply go over the U.S.
fiscal cliff? By going over the cliff, at least companies would
finally
have clarity in regards to the fiscal policy environment under
which they are operating. Moreover, any fiscal deals that would
follow in 2013 would then represent an improvement instead of the
detriment to the rates under which they would be operating. While I
continue to assign a low probability to actually going over the
U.S. fiscal cliff as well as a high probability that stocks would
move to the downside if we did, such a counterintuitive outcome is
at least worth closer inspection as we watch the drama unfold and
wait for a final deal to be reached in the next few weeks.
This post is for information purposes only. There are risks
involved with investing including loss of principal. Gerring
Wealth Management (GWM) makes no explicit or implicit guarantee
with respect to performance or the outcome of any investment or
projections made by GWM. There is no guarantee that the goals of
the strategies discussed by GWM will be met.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
See also
Time To Avoid U.S. Equities
on seekingalpha.com