Why Day Traders Love Elections

SHARE

What will tomorrow's elections mean for the markets and economy? To be honest, most investors, analysts, and economists I talk to are more concerned about 1) what the Federal Reserve will do next, and 2) what the eventual spillover from the bursting housing bubble will be to the rest of the economy. (Of course, many of these guys still check the betting markets and political websites throughout the day.)

The midterm elections looks to them more like a prologue to the 2008 presidential election, where the fates of the Bush tax cuts (due to expire in 2010) and entitlement reform (costs start soaring in 2010) will be determined. But the election results could still create some short-term trading opportunities, if you're into that sort of thing. From this morning's research notes, here are three quick takes on possible meaning of tomorrow's vote:

Michael Darda, chief economist, MKM Partners: "Unless there is a surprise sweep–meaning the Democrats take control of both the House and the Senate–we don't think the election will have a material impact on equity prices or asset allocation strategy. Our models continue to recommend an overweight on stocks and an underweight/short on Treasuries.... Spending likely would be restrained due to gridlock; divided government also would reduce the probability of an attack on Iran. At least this seems to be the message sent by plunging crude oil prices and a buoyant equity market."

Richard Bernstein, chief investment strategist, Merrill Lynch: "If the Republicans do retain both houses, then the market is likely to have a short-term reaction rally. If the Democrats win both houses, then the market is likely to have a short-term reaction sell-off. A split probably has little impact. Longer-term, if the two parties become more centrist, then the market is likely to respond favorably. Both parties might do so in preparation for the 2008 presidential election. A substantial surprise along these lines might be if the Democrats do win both houses, but end up being considerably more conservative than is currently expected in order to appear to the electorate as consensus builders rather than dogmatists."

Kim Wallace and Charles Marr, political analysts, Lehman Brothers: "[If the Democrats take just the House] market expectations have been geared toward this scenario at least since Labor Day, so we would expect a soft opening for equities as a headline reaction. [If the Democrats take the House and Senate] the equity market likely would sell off, and this mood could last a few sessions. The dollar might stumble a bit if traders perceive a weaker White House voice in trade and geostrategic decisions. We see little change for bonds. [If Republicans retrain the House and Senate] we would expect the dollar and equity markets to gain on the open, and maintain a relatively positive tone for the week. Concerns about whether the [Federal Reserve] is paying more attention to growth woes or inflation likely would keep bonds relatively unresponsive to this scenario development.… President Bush maintains control of the regulatory environment in all scenarios through administrative agencies and veto authority. Our sense is that Washington re-engages significant fiscal policy changes only after the next presidential election."

Oh, on that last point about what worries the Fed, Chicago Federal Reserve President Michael Moskow said earlier today that his "current assessment is that the risk of inflation remaining too high is greater than the risk of growth being too low." Moskow added that monthly job growth of about 100,000 is consistent with the potential growth of the economy without being inflationary.

If the rest of the Fed shares that view, it would give them more room and reason to raise interest rates. Last month, the economy created 92,000 jobs. But these initial monthly job stats look like low-ball numbers since they keep getting revised higher. Economist Edward Yardeni of Oak Associates has devised a back-of-the-envelope formula for adjusting the initial number to get a rough idea of what the real jobs numbers will eventually be. He takes the first-reported number–92,000 in the most recent case–then adds 41,000, which is the average second-round revision over the past five years. He then adds an additional 67,500, which is keyed off a longer-term revision that the Labor Department is currently conducting. Based on that formula, the real October jobs number was 200,500–twice what Moskow believes is the natural rate of employment growth in the United States.