Weekly Update: It's going to be a very interesting second half
(This is the second of two vacation-week pieces in which we look into issues confronting the economy and markets. Last week, it was education. Today, we focus on the pending election and fiscal cliff.)
Nearly every presidential reelection has been a referendum on the incumbent. And for this reason, the president’s approval rating has been a strong predictor of what the president’s vote total will be. No president has won reelection with an approval rating below 50%. Based on the current trajectory, President Obama needs a 7.6% unemployment rate to reach that 50% benchmark. This would require job growth of roughly 225,000 per month for the next three months, which no one realistically expects to happen. While President Obama according to the polls is winning in just about every swing state, it’s within the margin of error among registered voters. And his support in those states is below 50%, typically a sign of trouble for the incumbent. But it is worth noting that the average unemployment rate for swing states has fallen from 8.6% to 7.9%, much better than the economy overall.
The final result likely will come down to six states: Virginia, Florida, Ohio, Iowa, New Mexico and Colorado. In each of those states, about 48% will vote for Obama and another 48% will vote for Romney, Newsweek surmises. So, the fight will be over 4% of the voters in six states. That’s about 917,000 people, about as many people as live in the city of San Jose. Who are the swing voters? Mostly younger women, many with a high school education but no college degree. A chunk of them are Hispanic. It’s estimated the political parties, campaigns and Super PACs will spend in excess of $2 billion to reach these people, about $2,200 per person. They also will target 18-to-34-year olds, a segment that represents 24% of voting-age adults, up from 18% in 2008, and one in which nearly a third have put off marriage or having a baby due to the recession.
In swing-state commercials, Obama has targeted Romney’s work at Bain Capital. But those surveyed in a new USA Today/Gallup Poll said by more than a 2-to-1 margin (63% to 29%) that Romney’s business background, including at Bain, would cause him to make good decisions, not bad ones, in dealing with the nation’s economic problems over the next four years. Concerns about the economy top the polls of voters’ concerns—only 31% of Americans perceive their economy as doing well, according to a Pew Research Center report, and even though nominal GDP is at an all-time high, 5 million fewer Americans are employed today than at the prior peak. Also by 2-1, however, Obama was rated as more likable than Romney in the USA Today poll and, by double digits, those surveyed said the president better understands the problems Americans face in their daily lives.
Whoever wins is going to have deal quickly with the fiscal cliff, the combination of expiring Bush tax cuts and steep spending cuts mandated by last year’s debt-ceiling compromise. If nothing is done, it’s estimated that 83% of U.S. households would pay higher taxes, with the average tax increase totaling $3,701, and that as much as five percentage points could be shaved off GDP—enough to push a weak economy back into recession. Senate Democrats suggest that they want all of the Bush tax cuts to expire on Jan. 1, and then have Congress go back and retroactively enact middle-class tax cuts. But Strategas Research says this is not a practical solution given that the patch for the alternative minimum tax (AMT) expired last year and needs to be retroactively fixed by mid-December, the deadline for the IRS to include the fix in the 2013 tax forms. If not, 30 million middle-class Americans will unknowingly get hit with the AMT in early 2013.
Perhaps the AMT patch will serve as a legislative catalyst for a deficit-cutting deal in the lame duck session, though clearly, the threat of going over the entire fiscal cliff is not good for confidence for the next four months. The likelihood is low of anything happening before the election, which also happens to be about the time that the government is expected to reach its debt ceiling again. And if the fiscal cliff is not addressed shortly after the election, it probably won’t be addressed quickly in 2013. The new Congress is not sworn in until mid-January and the next president is not sworn in until a week later. With a 60-vote requirement, the majority party may have to use reconciliation, which takes nearly six months to complete. (Back in 2001, Bush didn’t have 60 votes for the tax cut, and therefore had to use the budget reconciliation process to overcome a filibuster. As a result, he didn’t sign the tax cuts into law until the first week of June.) Gulp. The window to get something done is very small.
No one really wants a repeat of last summer’s debt-ceiling showdown, which according to the Government Accountability Office cost the federal government an additional $1.3 billion in borrowing costs because all the uncertainty forced the Treasury Department to pay a premium. There are early signs of a potential compromise in which a bill being offered by Senate Democrats would keep the top tax rate on dividends and capital gains at 23.8% (inclusive of the 3.8% tax included in the Affordable Care Act). If enough Democrats favor tax rates on investment income in the mid-20s that Senate Democrats felt obliged to break with Obama on that issue, this would suggest that if Obama is reelected, the Senate proposal would be the rough range of a compromise with Republicans.
Of course, if Romney wins and, as polls currently suggest, Republicans control both houses of Congress, then the need to compromise becomes somewhat moot. About the only issue both sides seem to agree on is that Congress won’t allow the defense sequester, though it is unlikely to alter it before the election. Defense Secretary Panetta has said that the long-term effect of the sequester, coupled with the reductions in the overall defense budget agreed to last summer, would shrink the military beyond recognition over the next decade. After 10 years of these cuts, we would have the smallest ground force since 1940, the smallest number of ships since 1915, and the smallest Air Force in its history.
What else (the election edition)
Four more years? U.S. national debt has increased by an average of $64,000 per household since Obama entered the White House, and he’s on course to become the first president to run deficits of more than $1 trillion during each year of his first four years in office. Some perspective: If you were alive when Jesus Christ was born and spent $1 million every single day since then, you still would not have spent $1 trillion dollars by now. If Bill Gates gave every single penny of his fortune to the U.S. government, it would only cover the U.S. budget deficit for 15 days.
The Reagan barometer If the stock market senses Romney will win with an economic plan that offers long-term solutions, it will price that up before Nov. 6. After Reagan won, the market rose another 5% to 10% … then fell for about 18 months as the anti-inflation medicine was administered and the economy reentered recession.
Less than halfway home UBS says its work suggests that the percentage change in the unemployment rate is the best labor-market indicator to watch to gauge the outcome of the election. Seven of eight incumbents who saw unemployment drop by at least 5 percentage points won the popular vote. Currently, that rate has fallen by less than 2 percentage points from its recession high of 10.1%.
A strong finish? BMO Capital Markets notes that the annual return of the S&P 500 has been positive 75% of the time in all presidential elections, with first-half performance typically lagging second-half performance. Also, performance trends are typically much stronger in non-recession years.
Uh oh Since the end of World War II, the average length of the business cycle in developed economies such as the U.S. has been about 4½ years. Year four is now upon us. And seven of the last 11 recessions have occurred in the year after a presidential election; three others occurred in the election year. (That’s 10 out of 11.) Hmm.