Lately the market has continued its strong performance, closing in on highs not seen since spring. Many investors and commentators have claimed that this has resulted from the market’s growing consensus on next week’s elections.
The truth is that the market has been doing well lately not in anticipation of recent earnings reports – which have been very positive – or next week’s elections. Not that these different factors haven’t benefited the market. In fact, these are the reasons why the market put in several relative bottoms 4-5 months ago before rallying back to previous highs.
Many investors with formal training in finance will recognize this concept, as the stock market is said to be a leading indicator of economic activity. That is to say that it anticipates developments as opposed to reacting to them. This is why we continually preach that investors can’t make money from what has already happened, only by anticipating how the future will unfold.
According to this well-documented theory, it is safe to assume that the market was fairly certain of the outcome of next week’s elections several months ago; and how right it was. It is for this reason that the market resumed its upward trend months ago, as it began to anticipate the gridlock that would result in Washington from the likely outcome of next week’s elections.
In a somewhat strange phenomenon, anticipation of gridlock has been limited to the market as a whole; few cases can be found in the actions of individual companies. For the most part corporations are waiting for gridlock to be assured. This is why they haven’t been hiring or beginning any substantial expansion projects. Corporations have, however, built up large cash positions, becoming poised to act should political conditions become more favorable.
The fact remains that even if gridlock results after next week’s elections, there is still uncertainty of exactly what gridlock will look like. For example, though the creation of new spending bills may cease, should Democrats lose the House, corporations still don’t know whether Healthcare Reform withstand judicial scrutiny, or if Republicans can find a way to kill the bill through lack of funding.
Now, several months after the stock market ended a short-term correction and turned back up, the economy appears to be resuming its recovery as corporate earnings surprise investors the world over. This isn’t to say that all is right with the economy. This is far from true. There remain, for example, numerous problems which banks need to work through, illustrated plainly by recent headlines pertaining to the mortgage crisis.
What makes this truly interesting is the confluence of factors dictating the market’s behavior. For example, recent earnings reports are interesting in and of themselves, but even more so when coming just shy of election season as certainty continues to grow that the Democrats will lose the House, if not the Senate as well.
The question now facing financial markets, one which is being constantly settled by consensus, is what course of action will be taken by the new Congress beginning in January.
