Why you don’t need to worry about the US election

There's a lot of talk about whether an Obama or Romney victory would be better for the markets. But it's largely irrelevant. There's only one thing that matters, says John Stepek. Here, he explains what it is, and what you can do about it.

Unless it's very tight, we should know by tomorrow morning who's won the US election.

But how much does it matter for your investments?

The papers are full of data points showing how Democrats are better for the market overall, but that markets outperform in specific years under Republicans.

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Ignore it. It's all guff. There isn't enough data to make any of this stuff useful, except for entertainment purposes and page filler.

There's only one area that could make a really big difference to how markets react and that's in the candidates' attitude towards the Federal Reserve.

Here's why and what you can do about it

The key difference between the presidential candidates

On his Big Picture blog, Barry Ritholtz has a useful round-up of how the candidates differ assuming that they stick to their promises. Mitt Romney would be good for defence stocks and dirty' energy companies. Barack Obama is good for insurers and hospitals, due to his health service reforms.

But these little differences don't matter that much. A couple of stocks might go up while a couple of others might go down. It's not something to overhaul your entire portfolio over.

Then there's the 'fiscal cliff' question. This is a big deal potentially. But the outcome here is down to a lot more than who gets to be the next president. And the reality is that whoever wins, there's likely to be a fudge. The tax hikes and spending cuts will probably hurt, but they won't be as bad as the worst-case scenario makes out.

The one area where there seems to be a huge gap on policy, which could affect the market right away, is the next president's attitude towards the Fed.

If Obama gets back in, it'd be business as usual. Ben Bernanke, the current Fed chief, will hang on to power. We know that he is a fan of printing money via quantitative easing (QE). He'll keep doing it at every chance he gets.

If Romney takes over, investors don't know what to expect. He's talked much tougher on QE. He's no fan of the zero interest-rate policy either. And he wouldn't reappoint Bernanke when his term is up in 2014.

I'd agree with analyst Jim Bianco that it's this fear of a less accommodating Fed that has rattled the markets in recent months. The bout of market jitters came after Romney made a big comeback at the presidential debates. Investors have become "addicted to an easy Fed". The threat that this will be taken away has them nervous.

Many pundits are arguing that Wall Street would rather see a Republican win. That may be so financiers seem to feel a bit persecuted by Obama. But I reckon that fear of the end of easy money would override any warm glow they get from a more favourable tax situation.

So I suspect that - in the short term - a Romney win would hurt stocks and boost the dollar. An Obama win would probably see the opposite.

Mitt Romney won't stick with the hard money rhetoric

But how likely is Romney to stick with the hard money' rhetoric if he wins? As Capital Economics' Julian Jessop notes, it's one thing to rail against QE when you're in opposition, "but the priorities in government would be different".

If Romney did stick to the anti-Fed rhetoric, then he'd be doing it on a point of principle, rather than as a cynical, populist ploy to grab votes. Much as I'd like to imagine that a politician might one day put principles over expediency, I wouldn't bet any money on it.

The problem for Romney is that the stock market in the US performs the same political function as the housing market does in Britain. If prices are going up, voters think they're better off and they give the credit to whoever's in charge that day. If prices fall, they start to look for someone who can make them go up again.

So if Romney gets into power, and markets have a spasm of panic at the prospect of QE withdrawal, he will be on it like a shot. "A Romney administration would surely move quickly to reassure markets that there would be no immediate changes at the Fed."

In other words, beyond the initial shock, it'd be business as usual under Romney too.

The truth is, there's only one thing that's going to force the Fed to raise interest rates. And it's not Mitt Romney or any other US president. It's inflation.

As James Ferguson points out in the current issue of MoneyWeek magazine, the Fed's latest batch of QE is potentially very inflationary in a way the others were not. The US is hardly firing on all cylinders, but it is no longer battling to avoid a depression either.

In essence, James argues that when highly deflationary forces were threatening to suck the US economy down into depression, the Fed's QE was the thing that kept it from collapsing.

It's like running up a down escalator you have to run really hard even to stand still. But if the escalator suddenly stops, and you keep running at the same rate, you'll be at the top of the stairs before you know it.

The risk is that if the Fed keeps up with QE at a time when economic growth is mediocre, rather than downright awful, then inflation may ignite more rapidly than anyone expects. What should you be holding in your portfolio then? Subscribers can read James' story for more but government bonds certainly aren't on the list.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.