Recap 11-7-12: What Now?


Both Democrats and Republicans seem to believe that their case has been strengthened. Even though there was no change in party control, the victories by Tea Party candidates in the House suggests that there may be even less willingness to compromise on fiscal issues. Therefore, the odds of a fiscal cliff have probably increased. Republicans look likely to re-use their playbook from August 2011, while the Democrats are less likely to compromise. We will get a game of chicken – the question is when and for how long.

I’ve been espousing the view that the election could be risk positive, on the idea that it will remove uncertainty to some extent. But I may be wrong about that. The uncertainty around how the fiscal cliff gets resolved looks higher than ever. Both sides appear ideologically committed. As this gets more press, people could start taking profits, especially given that it is near year end and many real money participants are sitting on nice gains.

I think it’s important to note – especially for overseas readers – how the assumption that House Republicans will be more willing to compromise may be incorrect. Supporting points include:

  • In 2011, with many Tea Partiers up for re-election in 2012, the Tea Party Caucus was adamant that there be no tax hikes. The Democrats blinked, and most Tea Partiers believe that was a ‘win.’ A large majority of them have now been re-elected, (including the Caucus Chairwoman, Bachmann) with no election for another 2 years.
  • All but 13 sitting Republicans in Congress have signed the Tax Protection Pledge.
  • Most pundits appear to believe that, on average, new congressional members are more extreme than their predecessors. This continues long term polarization trends.
  • The lesson from the summer of 2011 is that ideologically driven representatives need to wait for the public feel desperate before being willing to compromise. The desperation provides political cover. Compromising before then will expose them to charges of being soft – and losing primary races, as many moderate Republicans found to their dismay this year.
  • And finally, Boehner said this: “With this vote, the American people have also made clear that there’s no mandate for raising tax rates.” At his press conference today, he offered essentially the same plan as the Republicans offered the summer of 2011. 1 for 1 tax hikes vs spending cuts. No tax hike on the top 2 tiers. And the bipartisan 1986 Tax Reform bill that he wants to emulate? That CUT taxes, as well as spending, on a 1:1 basis.

Additional points:

  • Obama is now more concerned about building his legacy than any election, which means he is more likely to do what he wants, rather than what will get votes.
  • Most surveys show that the vast majority of investors do NOT expect a fiscal cliff event, which suggests the risk is UNDERPRICED. More evidence of this is that the Vix has an 18 handle!

Historically, I don’t react too much to news – instead preferring to focus on the data. Usually that’s justified because the correlation between headlines and prices is unstable. In this case, however, the risks around this issue are likely to have a much larger impact on expectations than the possible evolutions in the data. However, the market may not acknowledge some of the issues above until the end of the month. In the short term, as new leadership voting is conducted within each party next week, a sense of complacency can persist.


  • Obama wins the election by a comfortable margin. Democrats increased their majority in the Senate, while the Republicans increased their majority in the House. The vast majority of Tea Party Caucus members won victories. The number of moderate ‘Blue Dog’ Democrats declined to 15 from 24.

Upcoming Data:

  • Wed: Swiss CPI, Japan Current Account, Australia Employment, Japan Eco Watchers Survey
  • Thu: BoE, ECB, US Jobless Claims, China CPI
  • Fri: China IP, Retail Sales, US UMichigan Consumer Confidence