EmailThat knocking sound you hear is history at the nation's doorstep. Soon, it will be let in by election results that determine who will be called commander-in-chief for the next four years and who will be occupying the seats of the 113th Congress.
Those are crucial distinctions because they will go a long way toward paving our nation's fiscal path, which is full of sinkholes at the moment created by Republicans and Democrats alike.
Most political pundits agree that there is unlikely to be a monumental shift in Congress. Some seats might change parties here and there, but the consensus view is that Congress is going to remain a bicameral house divided, with Republicans maintaining control of the House of Representatives and Democrats keeping control of the Senate.
The presidential race, on the other hand, is seen by many pundits as too close to call. The latest RealClearPolitics average of national polls shows President Obama with a slim 0.5 edge over Mitt Romney (47.9 to 47.4).
For the sake of hanging chads everywhere and some sense of political certainty, let's hope the presidential election is in fact decided without question on November 6.
A contested outcome is the last thing we need, especially when an uncontested outcome is certain to produce bitter political feelings as it is -- feelings that could ultimately drive us off the fiscal cliff.
Red, White, and Blue
Just imagine how the Republicans will feel if Mitt Romney wins the popular vote but loses the electoral vote. Conversely, just think how the Democrats will feel if President Obama loses the electoral vote by a narrow margin. These are admittedly low-probability outcomes, yet neither is an impossibility.
A look at the electoral map compiled by RealClearPolitics indicates 11 states are currently regarded as being toss ups. In aggregate, those 11 states -- Colorado (9), Florida (29), Iowa (6), Michigan (16), Nevada (6), New Hampshire (4), North Carolina (15), Ohio (18), Pennsylvania (20), Virginia (13) and Wisconsin (10) -- account for 146 electoral votes.
With the breakdown of states that are blue states and states that are leaning blue, the Obama-Biden ticket would garner 201 electoral votes, according to RealClearPolitics. For red states and states that are leaning red, the Romney-Ryan ticket would garner 191 electoral votes.
270 electoral votes are needed for election.
Ohio, with its 18 electoral votes, is considered to be the key battleground state for several reasons: (1) Ohio voters have correctly picked the president in the last 11 elections (2) no Republican candidate has ever won the White House without winning Ohio and (3) the last Democrat to win the presidency while losing Ohio was John F. Kennedy in 1960.
How do you like them buckeyes?
The Possibility of Polling Error
What if the polls are wrong, though, and it doesn't end up being a very close race?
Perhaps the GOP turnout will be much stronger than expected. There are some indications that could be the case with Romney gaining momentum in the polls since his first debate performance.
What's more is that independent voters might not be feeling as strong about President Obama's message as they did in 2008, raising the possibility that they will throw more of their support than expected behind Mitt Romney.
Conversely, what if independent voters continue to favor President Obama in large numbers, swayed in the final days perhaps by his leadership during Hurricane Sandy and employment data that has showed slow, yet steady improvement?
Reasonable arguments can be made on either side of the turnout issue, and on the manner in which poll results are compiled, that would make a convincing win by either candidate unsurprising in hindsight.
Arguably, a convincing win in the presidential election would do more to advance the prospect of a fiscal cliff compromise than a very close outcome would.
While the winning party is unlikely to have a mandate, members of the losing party might see a convincing win in the presidential election as a popular message that speaks to the desired course of fiscal compromise.
This is just speculation on our part. The point is that anything is possible.
A Compromise Risk
One view this year that proved to be spot on was that there would be no compromise on the fiscal cliff ahead of the presidential election. The conventional wisdom leading up to the election, however, is that a compromise will be reached after the election.
One thing to remember about conventional wisdom: it isn't always right. Another thing to remember about compromise: it doesn't always produce the best outcome.
We see a building risk for the equity market on both fronts since it is wedded to the views that a compromise will be reached after the election and that any compromise will produce a positive outcome.
That's putting a lot of faith in congressional leaders who have forged a partisan divide in this country that is as divisive it seems as anything seen since the Civil War.
While we are certain we won't hear calls for succession from the union (except maybe in Texas), we are far less certain about the prospect of a bipartisan spirit taking over after the election -- at least not in the lame-duck Congress which will be aptly named given its lame legislative behavior.
Unpopular Decisions Happen
Some politicians may in fact feel that the right thing to do for the nation's future is to let the fiscal cliff happen.
The short-term consequences of such a happening would be recession-inducing, as forecasted by the Congressional Budget Office, but those politicians might argue in turn that it would set the foundation for long-term growth as higher taxes and reduced spending would help get the deficit under control sooner rather than later.
We understand many people think that would be a ludicrous decision given the weak global economic growth we are now experiencing, but many people also thought it was ludicrous for Paul Volcker to hike interest rates to force a recession that tamed inflation, which in turn ultimately laid the foundation for long-term growth.
Different time, different circumstances we know, but unpopular decisions on the policymaking front are not without precedent.
The equity market would not take kindly to the forced austerity.
First of all, forced austerity is not priced into the market. Secondly, market participants are cognizant of the economic and social pain that forced austerity has imposed in the eurozone.
The possibility that a fiscal cliff compromise is not struck is a real risk that could be magnified, not minimized, in the wake of a close presidential race.
Tail Risk
If investors have learned anything since 2000, it is to expect the unexpected. More aptly said, the lesson learned has been to prepare for the unexpected -- the tail risk if you will.
In the case of the election, the tail risk would be a contested election. In the case of the fiscal cliff, the tail risk is no compromise being reached.
The former, while improbable, would make the latter more probable were it to occur.
Still, even if we know for certain on the morning of November 7 who the president will be, the tail risk of no compromise on the fiscal cliff will remain a real risk with a divided Congress.
The definition of the word compromise is a settlement of differences in which each side makes concessions. Neither side so far has shown any sign of bending.
Republicans continue to declare that there will be no income tax increases. Democrats continue to insist that upper-income earners must pay more in taxes.
All Talk and Inaction
We'll soon see if the tough campaign talk translates into legislative inaction that sends us over the fiscal cliff.
It is quite possible that lawmakers won't reach a compromise by January 1. If they don't, the market will at least need to have a strong sense that a compromise is going to be reached early in the new year.
Even then, however, investors need to be careful not to be deluded by the thought that a compromise of any kind can only produce a positive outcome for the stock market.
The complexion of the compromise, if there is one, will matter greatly. To that end, it will not be cause for celebration if it is agreed in a compromise that capital gains on stocks, regardless of the length of the holding period, are taxed at the ordinary income rate.
That is unlikely to happen, but it speaks to the point that the elements of a compromise must be thought through carefully by investors. Fiscal restraint imposed through higher taxes, lower spending, or both, will still be a drag on economic growth.
A Canned Response
There is a budding consensus that Congress will simply kick the fiscal can down the road, deferring the sequestration and passing temporary extensions of current tax policies with the exception of the Social Security payroll tax cut. This will be done, it is believed, to buy more time to come up with a better plan that helps avoid cutting the U.S. economy at its knees in the short term while putting it on a sustainable fiscal path for the long-term.
Kicking the can down the road is viewed by many market participants as a better alternative than getting kicked in the mouth by the fiscal can on January 1.
Choosing the less bad alternative now might trigger a short-term boost for the market, but it doesn't change the fact that the path of fiscal policy will still be uncertain.
That uncertainty has been bemoaned by businesses all year. We're not sure how kicking the can down the road does anything to make businesses feel more confident about making capital investments.
The market might find some relief in the short-term that the day of fiscal reckoning has been forestalled, but a lack of business investment will continue to weigh on the economy, which could lead to earnings disappointments down the road.
Letting the fiscal cliff happen, meanwhile, would be very upsetting to the equity market. It is not priced for that possibility. The market would suffer a material setback were that to occur.
What It All Means
We would like to know what it all means on November 7. Chances are we won't.
It is likely we will know who the president will be and it is likely that we will see a split Congress.
However, it is also likely that there will be bitter political feelings in the wake of the election.
That bitterness could be a deterrent to a fiscal cliff comprise, particularly if it is a very close presidential race, never mind a contested outcome that would trip history on its way in the door.
--Patrick J. O'Hare, Briefing.com
