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Another Spin of the Wheel

Kevin Flynn
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“We must take the current when it serves, or lose our ventures.” – William Shakespeare,Julius Caesar

The first week of November ushered in some important events – depending onyour point of view, disappointments and/or victories. At the top of the list is themid-term election, which in the end failed to deviate in any entertaining way fromits preceding polls. The Republican party took uncontested control of the Senate,increased its hold on the House and come January, has dominance on CapitolHill. Book-ending that result was the October jobs report, which was good but notgreat, disappointing my prediction of a stronger number (the unadjusted data washowever stronger, as you can see below in the Economic Beat).The full importance of the election result will not be known for many months, andthere is an abundance of material elsewhere on the subject. For myself, I wouldecho economist Austin Goolsbee’s remarks, who observed rather smartly thatthe chances of getting any deal done before the election had been zero, butwould now be cut in half.

There was the usual political show after the election of the two sides pledging tolisten to any reasonable request to pass reasonable legislation – with barelydisguised sotto voce observations that each side was perfectly willing to let theother agree to its own program and not much else.

I will sum up my own small mosaic of observations in this way – though thebalance of power has shifted from the election, the nature of Washington politicsis unmoved. No doubt there will be a flurry of symbolic votes and proposalsshortly after the new Congress is seated, but the essential calculus will bebusiness as usual: The Republicans do not have the White House, and wouldlike to get it back. In pursuit of this aim, the chances of President Obama gettingto sign a bill and even indirectly take credit for any major legislation, regardless ofwhich side of the aisle it originated from, are zero.

The GOP’s tactical goal will be a focus on only passing legislation that can beseen as a clear victory for the party. It’s natural self-interest. Far from wanting to negotiate with the President and risk the chance of handing him some symbolic victory, the party will prefer attempts to craft bills in the Senate that can attractthe half-dozen or so Democratic votes necessary to reach the magic sixtynecessary to override presidential opposition. To get those votes will probablyuse a carrot-and-stick approach, with the carrot being appeals to moderate, atriskDemocrats with some kind of mollifying gesture thrown in.The stick approach will be to soften up at-risk Democrats, most likely bylaunching a series of investigations (including the threat of impeachmentproceedings) to weaken the President’s public standing and thereby encouragedesertions predicated on self-interest. Such tactics do run the risk of turningpublic opinion back on the accusers, true, but the prospect of putting thePresident on the hot seat is pure political heroin for the junkies on Capitol Hill -for most, far too hard to resist. While the two chamber leaders, Speaker Boehnerand soon-to-be majority leader McConnell, are probably less keen on launchingany high-profile witch hunts that might backfire, as happened during the Clintonadministration, their more vocal (and less experienced) members may leavethem no choice.

As for the jobs report, it left unchanged the market’s perception of a rate rise inthe middle of 2015. The jobs totals showed definitely enough underlying strengthto worry the market, but the headline numbers are what get attention and setpublic opinion. The blowout number that I thought might spook the market (i.e.,rates could rise sooner) did not come to pass, but the net additions were muchbetter than you might guess from the adjusted total.All of the above suggests that we are living in the calm before the storm, thoughit may not seem that way in the next week or two. With 50 companies left in theS&P 500 index to report, the blended growth rate for earnings in the third quarteris now 7.6%, the same as the second quarter (the heavy mix of retail companiesthis month could push this figure down a bit). The main difference from thesecond quarter is that estimates were cut even lower just before the outset (inJune, Q3 earnings growth was estimated at 8.9%; by early October, 4.5%).The market behaved well enough last week in consolidation terms that I wouldordinarily think it ready for another move up. However, stocks are short-termoverbought, the post-election victory lap seems to be ending, and the bull-bearratio is flashing quite red, leaving markets more than usually susceptible to a joltof discord. The pre-Thanksgiving period is often a rough one for stocks, despitethe November-to-May period’s deserved reputation as one of outperformance -November performance itself usually lives off the first few and last few tradingdays. With Japan’s central bank now all-in and the Fed headed in the other way,that leaves only the ECB and China’s central bank as potential white knights forany (more than likely) further signs of economic weakness – and the ECB doesn’tlook ready act until next month.

In the meantime, the return of the dreaded polar vortex is going to blast thecentral and eastern parts of the country in the back half of next week. Most of thescare stories from earlier in the fall – Ebola, the Middle East, global growth,Russia-Ukraine – have been quiescent the last couple of weeks. Combined withthe steepness of the V-shaped rebound rally and the newly-reborn, backwardlookingconviction of momentum traders that everyone must be fully invested atall times, it’s just the kind of situation that Mr. Market loves for sticking out a legand tripping the unwary. The wheel so often spins right back to the same spot,doesn’t it?

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