Election 2008: Drawn-Out Dems Battle Could be Bad for Investors

"Election 2008" is an ongoing Money Morning series that looks for profit plays emanating from the presidential election campaigns.

By Martin Hutchinson
Contributing Editor

Hillary Rodham Clinton's unexpected primary victories in Ohio and Texas this week bring the prospect of a further lengthy struggle for the Democrat nomination.

Normally, investors shouldn't care - especially Republicans. The sight of Democratic candidates beating each other with saucepans for months on end brings innocent enjoyment to watchers, gainful employment to political pundits and journalists, and a modest improvement to Republican chances in November.

This time around, with the prospect of a protracted Democratic tussle, investors unfortunately have a cause for concern.

Over the next months, Clinton and Barack Obama will struggle for the few remaining primary delegates. In doing so, they will be drawn to appeal to the less educated, less-economically literate voters by making populist promises that make no economic sense, but still attract votes. We have already seen where that leads: Obama in Ohio denounced the North American Free Trade Agreement, promising to "use the hammer of a potential opt-out as leverage to ensure that we actually get labor and environmental standards that are enforced." Whether or not Obama succeeded in renegotiating or ending NAFTA, you have to worry about what such tactics would do to U.S. relations with Canada, a friendly country, sensitive to U.S. bullying, and the largest U.S. oil supplier.

Investors know that the economic differences between the two parties generally don't matter all that much, although there will be different profit plays to make depending upon whether a Democrat or a Republican wins the White House.

For instance, investors know that taxes will be higher if a Democrat wins, and that certain industries, notably defense contractors and pharmaceutical companies, tend to do better under Republicans. But a sensible investor recognizes that in a two-party system, the other side is going to win from time to time; indeed, an opposition victory may be a useful rebuke for a lousy performance by the party that you support.

For example, the British Conservatives would almost certainly have benefited had John Major lost the 1992 election to the unpopular Neil Kinnock. By working to win the election for Major, party activists condemned themselves to five more years of thoroughly inept government, during which party principles were repeatedly trashed, followed by more than a decade of opposition, after a revived and reformed Labor party cemented itself in power under Tony Blair.

In this case, however, both Clinton and Obama are showing signs of abandoning the traditional Democrat commitment to free trade. Free trade is an arcane economic issue, because its benefits are wide but spread very thin, so it's difficult for investors to make money off it. However, a move towards protectionism - for example, by renegotiating NAFTA as both Clinton and Obama suggest - would raise trade barriers that had been lowered and disrupt trade relationships that had settled into place after NAFTA passed in 1994.

To understand just how damaging that would be, just look back into history. Before 1914, Austria-Hungary was one of the more-prosperous regions of Europe, with relatively poor farming communities at its eastern border offset by the enormously wealthy cities of Vienna and Budapest, from which an astounding percentage of 20th Century culture, thought and science emerged. The so-called "Austro-Hungarian Empire" benefited from being more or less a free trade zone of 100 million people of varying languages and nationalities.

Following Germany's defeat at the end of World War I, Austria-Hungary was broken up, by the vindictive Treaty of Versailles, and reorganized into small states - Czechoslovakia, Austria, Hungary and Yugoslavia - that no longer had free trade relationships with each other. The barriers that had been put in place proved ruinous for the region's prosperity. At least initially, Czechoslovakia didn't fare so badly [though it ultimately fell prey to the envy of its German neighbor].

However, Austria was impoverished and turned Nazi. Hungary was impoverished and fell under a dictatorship. Not to be outdone, an impoverished Yugoslavia fell to both Nazism and Communism in different regions. The collapse of pre-1914 trading relationships worldwide was a major cause of the Great Depression and World War II. With Austria-Hungary, the creation of trade barriers caused impoverishment on a local scale that was so deep-seated that it didn't even start to lift until after those countries resumed unfettered trading after 1989.

Similarly, a lengthy primary campaign would cement protectionist policies in place among the leading Democrat candidates, and increase the probability of them following protectionist policies if elected. The principal losers from such protectionism would be those companies whose operations are located throughout NAFTA-member countries, or are situated across the world, in general. The U.S. auto industry's Big Three - General Motors Corp. (GM), Ford Motor Co. (F) and Chrysler LLC - each have major manufacturing operations in both Canada and Mexico, and supply the North American market on an integrated basis. The elimination of NAFTA would land yet another blow on those already-staggering enterprises.

Similarly, software giant Microsoft Corp. (MSFT) has operations all over the world, while The Boeing Co. (BA) - the largest U.S. exporter - has promoted foreign-supplier relationships specifically to improve its ability to sell aircraft in many markets around the world.

For investors, President Barack Obama or President Hilary Rodham Clinton would be but a moderate worry. But a protracted and savage primary campaign between the two - in which populist and economically damaging promises were made that later became actual policies - would be a massive market downer.

[Editor's Note: Money Morning Contributing Editor Martin Hutchinson has personally interviewed the economic advisors for candidates McCain, Obama and Edwards, and concluded that Obama and McCain would be the best candidates for investors. He last wrote about the "Potomac Primaries" in mid-February. For a full report on the "presidential profit plays," please click here. The report is free of charge].

News and Related Story Notes: