It is tempting to see yesterday's elections results as vilification of the
old adage, "You can fool some of the people some of the time, but you can't fool
all the people all of the time."
It seems people voted against an ill-conceived war in Iraq, despite a good
economy.
The debacle of the Iraq war, along with recent scandals, provided good headlines
and fodder for resentment. In addition, massive government spending gave the
impression to independents and even to staunch conservatives, that Republicans
were not governing in a Republican way.
The exit polls vary from region to region. But exit polls in some areas now
appear to show that the economy was in fact ahead of Iraq as the main issue on
voters' minds.
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What Went Wrong?
This begs the question of why the Republicans did not fare well when the economy
appeared so strong.
On the surface, the economy looked good. Jobs and wages were up. Unemployment
was low. Despite "stealth inflation," real interest rates (nominal less
inflation) were low and stock markets were at new highs.
[Editor's Note: The government is manipulating inflation data.
Read this free report.]
In answering this question, we feel that the commonly held political adage,
"It's the economy stupid," should more accurately read, "It's the pocket book,
stupid!"
When one looks beyond the general economic indicators and into peoples' pocket
books, we find a different story. It is a story that could be expected to breed
discontent, even anger, in some.
For the individual consumer, we see gas prices that rose alarmingly, acting as a
hidden tax on individuals. At the same time, we see personal debt rising to
record levels, just as house prices began to fall in earnest. This is a cause
for real concern to many consumers.
We also heard of record corporate profits and that the average salary of an S&P
company CEO was some $7 million a year. It appeared to many voters that tax cuts
and the increases in national wealth were not being distributed in a fair
manner. We believe this caused resentment and a costly loss of support.
Therefore, we judge it was a combination of Iraq, scandals, and the economy that
caused the major power shift in Washington to which we must now all adjust.
This was an election that was not won by the Democrats, but lost by the
Republicans.
What Do the Cards Hold for Investors?
So what will be the key effects of this power shift?
First, we believe that the Democrats will fight not on the old-line liberal
ground, but on the center ground. During the campaign, they changed their
rhetoric to sound more like Republican and it appeared to work. They have a
large number of right-leaning representatives who will make demands in return
for cooperation. They also will have their eyes on the 2008 presidential
election.
As governor of Texas, President Bush proved that he could work with Democrats.
He will now be put to the test in Congress. Nancy Pelosi's initial comments and
meeting with the president gave grounds for hope that the Democrats will work
with the president to avoid a political gridlock.
The main, immediate item for discussion will be Iraq. We feel that U.S.
withdrawal is imminent. We have long forecast that Donald Rumsfeld will be
replaced. As we go to press, we note that he has now patriotically offered his
resignation and is to be replaced by Robert Gates, a candidate likely to meet
with cross-party endorsement.
Sadly, Bush still persists in trying to tie the war in Iraq to the defense of
the American homeland. This does not bode well for bipartisan work in Congress.
He would be well advised to remember that defeat is usually a military necessity
imposed from outside, not a political option merely accepted from within.
We forecast that Robert Gates' new perspective will be to urge an early
withdrawal from Iraq, possibly dressed as a request by the Iraqi government.
Time Will Tell
Democratic views on such areas as free trade, health care (drugs), immigration,
a minimum wage increase, student loans, a windfall oil tax, and even allowing
for more consolidation of the airlines, will be negotiated. Here, the Democrats
have a most powerful card: agreement to President Bush's tax cuts after 2010.
In the meantime, the American bond and equity markets meandered downwards and
are now recovering, as investors assess the great power shift in Washington,
including an unexpected Democratic majority in the Senate.
The next few days will contain vital clues as to what investors can expect from
the new Congress, particularly on drug, steel, and defense stocks for instance.
Generally, markets like stability. The restoration of some discernable direction
in the American and indeed many overseas financial markets will depend
critically upon how soon Bush and Speaker Pelosi succeed in creating an
atmosphere of stability.
Editor's Notes:
