Traders and investors across the globe will be closely watching the US Presidential elections on Tuesday to brace for its impact on the stock markets. Presidential election outcomes generally don't change an existing market trend, but this time could be different.
President Obama's stated policies will plant a gut punch to the stock markets and his victory is more likely to be bearish for equities. Especially when you know that when the US markets sneeze, global markets catch a flu. Republican presidential candidate Mitt Romney is proposing incremental reforms and long term changes which can be bullish or neutral for the markets.
Before we get into the Obama-Romney discussion, let us look at the stock market's reaction to past US presidential elections. We will look at the S&P 500 index.
In 1992, when Bill Clinton was elected, the market was on a steady uptrend and the trend continued (Click here for the November 1992 chart). There was no big drama in the markets in November 1992 when he was elected. In November 1996, when he was re-elected, there was a nice bounce, but again it was a continuation of the trend (Click here for the November 1996 chart).
When George W Bush was elected in November 2000, the market had a strong drop, but the downtrend had begun a few months earlier. (Click here for the November 2000 chart). Also notice that in November 2000, the market, despite the huge fall, only came down to the previous month's low. The re-election of Bush in November 2004 led to a continuation of the uptrend and there were no dramatic price spikes or reversals. (Click here for the November 2004 chart). Finally in November 2008, when Obama was elected the market continued its strong downtrend. (Click here for the November 2008 chart).
The effects of a president's policies take time to work and to reflect in the stock market. It's for this reason that the markets don't change trends after a presidential elections. However, this time it's different. Obama has promised to let the Bush tax cuts expire. While this will take tax rates higher for several Americans, the jump in dividend and capital gains tax is what will hit the stock market directly. The top dividend tax rate is expected to go up to nearly 40 percent from 15 percent.
The top rate on long-term capital gains will go up to nearly 24 percent from 15 percent and the short-term rate goes up to nearly 43 percent from 35 percent. The election of Obama will have an immediate effect on stocks as people would like to book their long-term capital gains in 2012 before taxes go up next year. This will push the stock markets down. Also, with dividend taxes going up, it will make stock investing less attractive, which reduces buyer support for the markets.
The markets are near their peaks from a multi-year perspective. So it makes sense for investors to sell and book profits, given the tax headwinds for the stock markets an Obama victory would bring.
This time is different from another perspective, too. Even if the Republicans win the two legislative branches, they will not be able to stop a tax increase as Obama will veto the extension of the Bush era tax cuts. Any way you see, the tax cuts are set to expire unless they are extended or made permanent by the two legislative bodies and the President. Simply put, Obama does not have to initiate bad tax policy to sock the stock market, he just has to sit back and see it take effect. So unlike other elections this one could have an immediate effect on the stock markets.
Now it's always possible that eventually there will a compromise and some tax solution will be worked out. But on the day after the election, if Obama wins, no solution will be on the horizon and the markets will be jittery.
Dollar breaks out
Adding to the bearish bias of the stock market is the break out of the US Dollar index (Click here for the dollar index chart). As we have said in our earlier articles, the dollar and equity markets are inversely correlated. Hence when the dollar rallies, the equity markets fall. The reason for this is simple. The US dollar is considered a safe haven and equities a risk play. When the appetite for risk wanes, investors junk equities in favour of the dollar, leading to a fall in the former and a rally in the greenback.
A continuation of the rally in the US dollar index can prove to be a negative for stocks.
The Nifty finally broke the support level of 5,630 last week and had a correction on Wednesday and Thursday (Click here for Nifty chart). However, a huge rally in the US on Thursday led to a strong Nifty rally on Friday. But the US markets tanked the next day, which will put pressure on the Nifty. Unless the Nifty closes above the 5,725 target, the down target of 5,525 is still in play. That is area of the huge gap, which is a support level. We have spoken of the gap in the previous articles. One of the reasons for the Nifty bounce last week is a small gap level shown on the chart. That level provided support.
George Albert is Editor, www.capturetrends.com
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