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Markets have rallied on the belief that resounding Republican victories in yesterday's (Tuesday's) midterm elections will reset Washington agendas and lead to more business-friendly policies.
However, market participants may be surprised to find that the successful pursuit of three major Republican principles could initially sink stocks and bonds before creating a base from which they might rally later in 2011.
Indeed, following the adage "buy the rumor, sell the news" might be the best strategy for investors right now.
Republicans generally advocate a strong dollar, lower taxes and less government spending.
But consider the following three points:
1. Any sudden and dramatic rise in the dollar would initially reverse the profitable overseas revenues of corporations, lower earnings expectations and sink stocks.
2. Tax cuts – without off-setting spending cuts on pork-barrel and budget-busting special interest giveaways – would initially increase the deficit and sink bonds.
3. And a rush to cut government spending on entitlements, unemployment benefits and stimulus programs would initially panic consumers and slow economic growth.
In the long-term, a strong dollar, lower taxes and less government spending are exactly what this country needs. But, in the short-term, politically motivated quick fixes could panic markets.
Here's a look at what the markets are facing and where they may go.
Historically, stocks rally strongly after midterm elections. Then again, historically, September and October are the worst months for stocks. Since markets just had their best September-October run in 70 years, history may not be our best guide at this juncture.
First, it's important to understand why stocks, commodities, gold and bonds have been rising while housing prices keep falling, unemployment remains stuck near 10%, and none of our too-big-to-fail banks are out of the woods.
Rallying markets are being driven by a falling dollar and the U.S. Federal Reserve's quantitative easing stimulus.
Stocks prices are rising because companies are increasingly generating revenues in the global marketplace. In spite of flat U.S. growth prospects, emerging markets and developed world economies have an appetite for U.S. goods and services. The falling dollar raises the purchasing power of our trading partners around the world.
More importantly, when earnings generated in foreign currencies are translated back into cheaper dollars, the foreign exchange gain drives sales numbers and net profits higher.
Higher earnings combined with the tax advantages of channeling overseas revenues through off-shore tax havens, used by the likes of Google Inc. (Nasdaq: GOOG), Microsoft Corp. (Nasdaq: MSFT), Johnson & Johnson (NYSE: JNJ) and other giant multinationals, have been driving robust stock market gains.
The falling dollar also has been driving commodity prices higher because most commodities are priced in dollars. A falling dollar means it takes more dollars to buy the same quantity of a commodity.
Additionally, commodities have been rallying, as has gold, because investors fear that the dollar, the world's main reserve currency, is losing its status as a safe haven investment.
The debasement of the greenback by the incessant printing of dollars to buy an endless stream of bills, notes and bonds issued by Treasury to finance the growing American deficit is creating a widespread fear of future inflation.
Commodities and gold are traditionally excellent hedges against rising inflation, which is another reason they have been rallying.
The Federal Reserve has been doing its part to keep the dollar weak by promising a second round of quantitative easing, or "QE2" as it's being called, which will result in the central bank buying more government bonds and mortgage-backed securities to keep interest rates low to stimulate the economy.
In the short-run, the Fed's intention to drive real interest rates into negative territory has been a boon for bond prices.
Printing dollars to keep interest rates low also has inspired leveraged bets on commodities, gold, bonds and stocks. But, while yield-hungry investors reach for higher returns, low rates haven't helped the economy or impacted high unemployment.
Enter the Republicans.
Swinging the economic, financial and regulatory pendulum from one political extreme to the other has only driven us from boom to bust to boom and back again, over and over.
Republican principles are good for America – but so are Democratic principles.
The Republican agenda is about more than just the pursuit of a strong dollar, lower taxes and less government. And, the Democratic agenda is about more than just the pursuit of a social safety net, equal rights and conscientious government.
The problems we're facing as a capitalist-democracy can't be answered just by Democrats or just by Republicans. They were never meant to be. We are a nation of free men and free thinkers. And, by the grand design of our Founding Fathers we are supposed to debate the agendas before us and let the majority decide our direction.
I'm not for the Republicans and I'm not for the Democrats. They are like gangs to me. They might as well be the Sharks and the Jets, or the Bloods and the Crips. They're fighting over turf. Only it's not their turf, it's our America, and they are destroying it.
Until we see the gang warfare stop and thoughtful, bipartisan debate and bipartisan legislation enacted to fix the long-term problems and economic difficulties America faces, we might do well to take any profits we have on the news of these midterm elections.
There will be bloodletting and it may prove prudent to keep your investment capital out of harms way.
But, if our legislators begin to take prudent action and promise to work together to address the harmful unintended consequences that result from honest and fair regulations and laws they enact – that's a farfetched rumor I would buy on.
[Editor's Note: Shah Gilani, a retired hedge-fund manager and renowned financial-crisis expert, walks the walk. In a recent Money Morning exposé, Gilani warned that high-frequency traders (HFT) were artificially pumping up market-volume numbers, meaning stocks were extremely susceptible to a downdraft.
When that downdraft came, Gilani was ready – and so were subscribers to his new advisory service: The Capital Wave Forecast. The next morning, because of that market move, investors were up 186% on a short-term euro play, and more than 300% on a call-option play on the VIX volatility index.
Gilani shows investors the monster "capital waves" now forming, and carefully demonstrates how to profit from every one.
But he doesn't stop there. He's also the consummate risk manager. As the article above demonstrates, Gilani also makes sure to highlight the market pitfalls that can ruin years of careful investing and saving.
Take a moment to check out Gilani's capital-wave-investing strategy – and the profit opportunities that he's watching as a result. And take a look at some of his most-recent essays, which are available free of charge. Those essays can be accessed by clicking here.]
News and Related Story Links:
- The Capital Wave Forecast:
Official Website. - Money Morning News Archive:
Columns by Shah Gilani. - Money Morning:
Investment Strategies: Three Ways to Profit – No Matter Who Wins Tuesday's Midterm Elections - Money Morning:
Question of the Week: Readers Eager for U.S. Economy Overhaul After Midterm Elections - Money Morning:
As QE2 Looms, Is the Fed Focusing on the Wrong Things? - Money Morning:
Will Midterm Elections Ignite a Stock Market Rally? - Money Morning:
Three Ways to Brace for a Double-Dip Recession: Recession-Proof Stocks - Money Morning:
An Open Letter to Washington: How to Fix the Deficit and End the Bush-Tax-Cuts Debate - Money Morning:
What to Expect from the Federal Reserve's Next Round of Quantitative Easing
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.
Shah obviously you are a democrat from the likes of your comments.
Bi partisan are you kidding, nowhere did you mention Obama and his communist agenda.
And nowhere did you mention the dangers of what the fed is doing.
No he did not mention "Obama and his communist agenda". He unlike you, seems to express reality and not propaganda. Good luck.
Larry, I suggest you open your eyes and ears and pay close attention to Pete's comment, and above all, take it seriously. it is not propaganda he is talking about, it is the scary truth and nothing more. Watch and see what is going to happen to this country in the very near furuture. Obama's commusocialist agenda and the fed is one. And, they are not playing or caring for the American people. Keep a peel eye in the events to come and you won't be so quick with your comments.
Good advice, Maria….
We would do well to all keep our eyes open and to look for ways to turn that vigilance into the kind of action that could still fix the many problems this country, and its economy, continues to face.
William Patalon III
Executive Editor
Money Morning
Dude, please. Look up the definition of communism in the dictionary. It's where the gov't takes over everything. All the paranoid psychotics are hollering because we lent money to the banks and large auto mfrs saving 1000s of jobs in America and most of it was paid back with interest. Save your mental illness for your psychiatrist's office. She can help you with some psychotropic meds.
Over the last two years Republicans have opted out of governance and refused to participate. Their success in the latest elections is an encouragement for them to continue taking that position–e.g. it hardened that position. The election not only removed Democrats from office, it removed them across the board, including many moderate Democrats who were attempting to work with Republicans. In addition, right-wing Republican candidates have managed to remove many moderate Republicans from office, which will further reduce opportunities for bipartisan agreement. The result will be an ugly stalemate in Washington. As you wrote, there is no reason to expect serious debate or useful legislation to arise out of this election; invest accordingly.
The Republicans and the even-more-hardline-frothing-at-the-mourh Teabaggers weren't really mad about government spending–at least not when Bush was President. The TARP and the bailouts started when Bush was in office. It was only when a mixed-race Dem with a Muslim name got elected that they wanted to "take their country back." (Back to 1929!)
Obama's spending makes Bush look like a miser. Take a look at the charts. The deficit was decreasing 2006 and 2007 until Pelosi took over, it started climbing and then when Obama got in, it sky rocketed. Really, take a look at the facts. They don't move based on your wishes.
Don't confuse me with the facts, my mind is made up!
Shah –
You seem to be one of the few who has their eye on the ball.
Both parties seem to want to rely on ideological formulas to address problems, rather than rising to the challenge and questioning whether their cliche answers will actually provide solutions.
Republican's version of lasseiz-faire is typified by the BP disaster in the gulf of Mexico. They seem to long for a 'Daddy Warbucks' – but what they get is Jack Welch and Tony Hayward.
Democrat's version of a mixed economy is typified by cap and trade and the kind on monster health care bill we are now stuck with.
About all the two parties have in common is a desire to cater to the worst of Wall Street's desire to be masters of the universe.
Whatever way you look at it, political and monetary perspectives turn utterly ugly for the US.
And do not forget that the Chinese, amongst many others, holding excessive US debt, are a serious threat to the country. Political America would do better getting a bit nimble and refrain from too much provocation. Chinese must be perfectly aware of the precarity of their holdings, but if they had to choose between loosing face or money, I bet they rather loose money.
But "Pete" has said it all. As long as some Republicans view the President as a Communist, there will be zero chance of bi-partisan anything.
By the way, I remember the Soviet Union collapsing about 20 years ago. Calling someone a Communist is SO old fashioned.
What's "ugly" about stalemate? it's the best of all possible political worlds, none of which are good.
Both parties have grown govt over the decades.What we have in this country is a Fascist Democracy.Big govt with excess power run by idiots(the American voter).We would be better with a dictatorship run by a few smart people or a much smaller govt, run by idiot Americans,that couldn't do much harm.We once had the smaller govt and we were the equivalent of what China is today.If China wants to continue the fast wealth increases for it's people they better avoid becoming a Fascist Democracy and stay an authoritarian one.
Well said jj, but valid for quite a few other countries.
Fewer entitlement programs is what we need.
Social Security was a contribution plan in the beginning,
if you contribute now, you collect later.
But now, it's for anybody from anywhere regardless.
Taxpayers are over burdened with everything.
There's a box in Washington, DC labeled "regulations". Inside are all the jobs the manufacturing sector needs. Alas, the box is guarded by fanatics. Were the United States anything like the Boy Scouts, (having adult supervision), the Red Team and the Blue Team could sit down and talk about relaxing some of the 5 to 50-year-old regulations. Maybe a reverse sunset, where we could take a holiday and fade back in later. But we don't have adult supervision, we have exactly the Gangster Government described above. The Bush and Obama gangs are just fighting over the choicest organ meats before the American Corpse begins to decompose.
I study the USA financial news daily even though I live many miles away in NZ, as what happens in America affects the world.
I make no comment about your political parties but I take my hat off to Shah Galani on his comments about the 'left' versus 'right' political gangs being more about 'turf ownership' than doing what is right for all the people, because this is a world wide problem with adversary based political systems.
The end result is the middle income earner family is slowly but surely becoming the new poor.
Consensus for the good of all. You never know, it just might work.
Not quite. The difference is the Democrats intend to destroy the middle class, and the future of their own supporters. The Republicans who intend the same must do so privately. (Although in Bush's case, it became obvious.) If you lived here and participated in politics as I have you would understand: The Democrats believe that farmers cause famine and doctors cause disease and Govt causes Utopia. (And it does for them). The Republicans behind the scenes know this and conspire to protect their interest groups (and they sometimes do protect the powerful). Informed voters are therefore left with voting for Democrats who intend to destroy them (behind the scenes), or Republicans who pretend otherwise (behind the scenes). When given the choice between someone who will literally insult you, curse you, and dismiss you (and I finally gave up on the Dem's rather than experience a severe mugging), or seeking someone who will pretend to listen (and maybe isn't lying), what would you do? We who support Republicans are attempting to not only save our wallets (literally) but also save the skins of those global citizens who surely must starve if the Democrats succeed.
Im seriously considering that escape to Costa Rica with all the cash i can carry.
Many of these comments seem to me to have merit, I can only suggest that to read widely, (without judgement,) to try and think clearly, to look at the past objectively, – (eg Thomas Jefferson) and try to see where we are going, – and want to go, – without condemning anyone, just leaving any judgemental language totally to one side, may lead us to a place where clarity may start to emerge.
Cheers,
Geoff Thomas.
Australia.
Really? Do you eat off your neighbor's table? My kids and I pay these bills – and receive nothing in return. Their kids eat off my table and openly spout their contempt and derision and name-calling for us. Pardon my skepticism, but I doubt you would tolerate it for a moment without being forced to do so.
John mistakes being" ignored and disregarded" as"opting out"Don't hold you breath waiting on "bipartenship.Ned is dead.Better watch the man with the printing press[electronic.] He is the one with the"hammer"
Saha I love your definition of the two main political parties as "Gangs fighting over turf". This deifition equally applies here in Australia where the "common man or woman" is also subjected to damage to the economy where bad decisions are made by teh people in control of the economy".
Steve
Australia
P.S. Please dont get too cut up about Communisim – its dead, a failure, a relic of the past and you need not fear it ever getting a hold on the USA.