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Expect a Post-Election, Fiscal Cliff Volatility Surge

Whoever wins the presidential election, equity market volatility is likely to surge in November and December, as the fiscal cliff takes center stage while bruised and triumphant egos clash with each other in the nation's capital. Anyone who expects Republicans and Democrats to sit down and merrily sing "Kumbaya" together is deluding themselves, LPL's chief market strategist Jeff Kleintop said in so many words to a group of top marketing executives in Boston at the Growth and Innovation Forum sponsored by Spectrem Group and Financial Advisor magazine on October 24.

"What worries me" is a strong reaction by losers and potentially winners in the days immediately after a close election, Kleintop said. He envisioned a scenario emerging from a close election in which the winners interpret a narrow victory as a mandate and the losers decide to stonewall.

"A lame-duck session [after Thanksgiving] will be ugly," Kleintop predicted. "A grand compromise is unlikely. Markets are whistling past" the fiscal cliff.

As evidence, he cited a statement by New York Senator Chuck Schumer last week saying that any cut in the top marginal tax rate -- even if accompanied by an offsetting elimination of deductions as outlined in the Simpson-Bowles plan -- was unacceptable. Contrast that with the probable intransigence of Republicans aligned with Grover Norquist, and the picture of a Mexican standoff emerges. When one looks back at what happened during the budget negotiations in the summer of 2011, investors should remember that a more than 10 percent decline in the Standard & Poor's 500 didn't bring Congress to its senses.

If President Obama loses, he is unlikely to sign a temporary or permanent extension of the so-called Bush tax cuts as his final act, Kleintop noted. If Mitt Romney is elected and Republicans gain control of both houses of Congress -- a scenario that looks increasingly possible -- they are likely to temporarily extend the tax cuts while taking several months to alter the tax code.

But historically the "makeup of Congress" has proved far more important than who occupies the White House, Kleintop maintained. If the status quo stays in place with Obama winning and Congress remaining in place, it might provide an environment most conducive to a faster fiscal cliff fix, according to Kleintop. Ironically, however, a divided Congress historically has produced a mediocre economy and 3 percent annualized equity market returns.

When it comes to the presidency, equity markets have typically returned 6 percent under Democrats and Republicans alike, according to Kleintop. Investors should long for a return of the Whig Party, which gave us such inconsequential presidents as John Tyler, William Henry Harrison, Zachary Taylor and the memorable Millard Fillmore. During their administrations, equity returns averaged 15 percent.

- Evan Simonoff, Financial Advisor Magazine, October 26, 2012


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