Obama, Take Two

President Obama won re-election on Tuesday. Stocks fell big at Wednesday’s open, which some may view as the market’s verdict. However, in our view, this is normal sentiment-driven volatility and not predictive of returns through the end of 2012 or into 2013.

Investors who favored Mitt Romney likely view a second Obama term as a harbinger for poor stock returns now and in the period ahead. But as we’ve written frequently in the past, ideology is another form of bias that can blind you to reality. Naturally, anything can happen to shake stocks in the coming months. However, some factors to consider.

First: Obama’s win likely wasn’t a market-moving surprise. Though stocks were volatile on Wednesday (as they were Tuesday, incidentally), President Obama’s win was consistent with polls, which were tight but largely predicted Obama winning the Electoral College. Intrade (a betting site that has fairly consistently predicted past election outcomes) had the odds of an Obama win at or above 65% for many weeks.

What’s more, Tuesday’s win was decisive. Markets prefer clarity, and through the end of 2012, we won’t have hanging chads hanging over the market.

Second: There’s no historical evidence one party is materially better or worse for stocks. Stocks have risen under both Democratic and Republican Presidents, and neither party is more or less likely to preside over bear markets. To wit, in the nearly four years President Obama has been in office, global stocks have been in a sustained bull market, with US stocks leading the way—up 75.6% and 92.5% respectively.*

Though party hasn’t mattered for stocks overall, the president’s party can impact risk aversion at certain points in the election cycle. For example, average election-year returns are best under these scenarios: a newly elected Republican (which didn’t happen—averaging 18.8%) or a re-elected Democrat (which did happen—averaging 14.5%). Inaugural year returns (i.e., 2013) are best under a newly elected Democrat (22.1%) and second best under a re-elected Democrat (8.9%). Inaugural year returns are actually worst under a newly elected Republican (-0.6%). Since WWII, stock returns have been double-digit positive in every Democratic president’s inaugural year, first or second term, with the exception of Carter in 1977, when stocks were down a mild -7.7%.**

Third: Gridlock. No matter who is president, inaugural-year returns tend to be variable—usually up double-digits or down—few middling years. The difference tends to be gridlock.

New legislation is nothing more than the redistribution of money, property rights and/or regulation. Humans tend to feel the pain of loss more than twice as intensely as they enjoy the pleasure of gain. As such, if there’s an increased risk of legislated redistribution, risk aversion rises, leading to poorer returns.

Hence, markets love gridlock. Now, gridlock doesn’t mean nothing can happen. It just means fewer extreme things can happen—making gridlock a material market positive.

And we are set up for some serious gridlock for the next two years. The Democrats have the White House and a Senate majority. But Republicans can still filibuster at will, and they have a House majority. Sound familiar? That’s exactly the scenario in place since 2010’s midterms. Global stocks are up since then, and US stocks are up more—and both the global and US economy have grown.

Fourth: No one wants to fall off the “fiscal cliff.” Gridlock is assured, but that doesn’t mean politicians will be helpless to stop the much feared “fiscal cliff.” At this point, both sides of the aisle (and the President) are claiming “automatic” spending cuts and tax hikes must be forestalled. The 2014 Senate race structurally favors the Republicans—they have 12 seats up for election to the Democrats’ 20, and at least 9 of those Dem seats are in states that are traditionally red but went blue on Obama’s coattails in 2008 and 2012. Those will be tough races, and Democrats won’t want to face voters who may blame them for a recession. Democrats will compromise with Republicans, with the support of their leadership, to push back and/or rejigger many of the fiscal cliff elements.

In our view, the fiscal cliff will get leveled, probably at the 11th hour. However, even if it didn’t, the fiscal cliff is really more of a plain. Government spending has already detracted from headline GDP growth in 9 of the past 11 quarters. Projected spending cuts in 2013 are at about the same level seen in 2011—and recession didn’t occur. And spending is still projected to grow overall in the coming years. Then, too, we cut overall government spending by a similar amount projected under the fiscal cliff following the 1990-1991 Gulf War. Thereafter, of course, we got ... the 1990s. Which isn’t to say we foresee that exact outcome this time, but it argues against enormous, predestined downside for the markets and/or the economy simply because of spending cuts.

On the tax hike side, about a third of the projected amount presumes the alternative minimum tax (AMT) patch won’t be passed. But we are supremely skeptical 2013 is the year politicians finally decide to not patch the AMT. If they don’t, 36% of all taxpayers would be subject to it. That would make one big, angry constituent block motivated to vote in 2014.

It’s impossible to make a short-term forecast and we won’t endeavor it. However, our view 2012 ends with nicely positive full-year returns remains intact.

For more on our views on elections and their impact on markets, please review the following:

A Column Ripe for Ignoring IBD

Fuzzy Facts and Other Political Fallacies, MarketMinder

A “Fine” Economy--and Blinding Bias, Forbes

Scaling the Fiscal Cliff, MarketMinder

* Thomson Reuters, MSCI World Index total returns net of dividends, S&P 500 total returns, from 1/20/2009 to 11/06/2012.

** Global Financial Data, Inc., as of 01/19/2012, S&P 500 Total Return Index from 12/31/1925 to 12/31/2011. The S&P 500 Total Return Index is based upon GFD calculations of total returns before 1971. These are estimates by GFD to calculate the values of the S&P Composite before 1971 and are not official values. GFD used data from the Cowles Commission and from S&P itself to calculate total returns for the S&P Composite using the S&P Composite Price Index and dividend yields through 1970, official monthly numbers from 1971 to 1987 and official daily data from 1988 on.