Political cooperation and the markets By: Gabriel PotterMBA, AIFA® 2014.09.04

Approval ratings near all time lows

Only 40% of Americans are satisfied with President Obama’s direction for the country.  Congress earns the ire of both sides of the political spectrum and has a spectacularly low 14% approval rating.  What is the reason for these poor marks? 

Approval rating is a complex, deeply personal evaluation of a variety of factors including domestic policy, foreign policy, likeability, voter fatigue, patriotism, luck, and timing.  At risk of over-generalizing the many disparate causes for unhappiness into one single adage, made famous by Bill Clinton’s campaign strategist James Carville, “it’s the economy, stupid.”   Given the 40% approval rating for the President, we note a corresponding dissatisfaction which the majority of Americans - 60% according to a recent NBC / Wall Street Journal poll - have with the state of the economy. 

Political polarization and the 2014 mid-terms

Despite a stellar recovery in home prices, equity valuations, and unemployment rates, the majority of Americans are not satisfied with the status quo and desire change. Of course, there is no overwhelming mandate for what that change should be. From the political right, there is a clear argument that overreaching executive actions, notably the $800 billion stimulus package and the heavy handed implementation of the Affordable Care Act, have hampered the recovery.  From the political left, there is a palpable disappointment that the President has not measurably improved economic well being for the lower and middle classes.  From the political center, there is a frustration that no corrective action seems to be politically viable. The political center has a great basis for pessimism, since political polarization is at all time highs and likely to stay that way.  In fact, Pew Research now has an entire heading on their site, http://www.pewresearch.org/topics/political-polarization, devoted to measuring the division between disparate voting blocs and their representatives.

Given the long standing animosity, we expect each side to blame the other, no matter how disingenuous the argument or how evenly the blame could be spread between both parties.  We should expect the rhetoric to remain elevated, at least for the next few months as the 2014 mid-terms play out.  Current projections from evidence based analysis, including Nate Silver’s, give an edge to Republicans in the mid-terms, meaning they are the odds-on favorite to regain control of the Senate.  However, even with a Republican majority in both the House and Senate, the President’s lame duck status gives him a lack of incentive to cooperate over his last two years in office.  In short, if the analysts are right, the government will probably stay divided for the next few years.

Westminster Consulting’s blogs and newsletters (e.g. “The US Downgrade” in August 2011) have noted a direct causal relationship between political rancor and economic and market damage.  However, these examples generally feature shocks absorbed through some direct action such as a self-imposed debt ceiling crisis or government shutdown.  At the moment, there is dissatisfaction with the status quo, but there are relatively few initiatives coming from Washington.  The appetite for brinksmanship has subsided, given the political fallout from previous fiascos, so self-imposed crises should be rarer.  Instead, the probable scenario is that no material legislation will occur given the continued stalemate between Congress and the White House, even when there is potential for cooperation.

For instance, we considered the example of corporate taxes back in October 2013 (i.e. “A Perfect World” blog) as an area with potential bipartisan support.  As a reminder, the United States has some of the highest corporate tax rates in the world.  To compensate for the high rates, some companies have effectively lobbied for exceptions.  Thus, some companies pay no taxes and now benefit from an unlevel playing field.  High corporate tax rates are, at very least, hindering corporate strength and repelling potential commerce offshore. 

There is unity on some goals for corporate tax reform, but deep divisions on how to approach the problem.  The left wing is framing the issue as a civic duty, or corporate patriotism; this approach is echoed by Senator Elizabeth Warren and Treasury Secretary Jack Lew, but this approach feeds the narrative that Democrats hate businesses.  Meanwhile, congressional Republicans are trying to designing legislation to limit corporate tax inversions (i.e. reincorporating a foreign subsidiary as the new parent to avoid high US taxes), but offering deep compensatory cuts to corporate taxes, beyond the comfort level of Democrats, necessary to get legislation through both houses without risk of a veto.  These differences in approach and scope of potential solutions may stifle cooperation between both factions despite wide bipartisan agreement in the general goal.

Do we need political cooperation?

In summer of 2011, the origin of the modern debt ceiling crisis, our central premise had been that the US would be in a better position if there was higher cooperation between Congress and the President.  However, is cooperation still as favorable if the new alternative, the status quo, is simply inaction?  Our political system requires significant majorities to enact change, with a great deal of veto power, checks-and-balances, filibustering, or similar obstructions available to empowered minorities.  This separation of power was created, by design, to prevent small majorities from making overarching changes to policy.  Perhaps, by accident, the framers instilled a system that favored economic stability through political inertia.  Might gridlock and government non-interference sometimes be better for the market?  Perhaps the consistent enforcement of the laws, flawed as they are, is a better environment for companies to thrive than a continual flux in the regulations which corporations must constantly adapt to? 

There is market research which suggests divided government is good for markets, although a causal relationship between political party control, divided or otherwise, and market performance is difficult to prove.  For example, Democrats have often pointed out that the market historically has outperformed when Democrats occupy the White House.  However, comparing market performance during any particular President’s leadership – Democrat or Republican – might fairly be lagged a few years to let the effects of new initiatives wend through the real economy.  Economies are complex, with millions of different actors and extraneous factors.  Given this complexity, pundits can select, reinterpret or simply ignore the facts to reinforce their worldview.

On the other hand, there is solid evidence to support the notion that Americans prefer divided government to counterbalance the excesses of any particular ideology.  For example, Gallup has never recorded a preference for one-party government higher than 38%.   At least there is one silver lining to the lack of reform on immigration, corporate taxes, and entitlement spending. 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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