After the Fed and Election: What's Next for Wall Street?
There's little argument that this week's election and Fed meeting are hugely important for the direction of the market. But what happens next?
As the lyric went in the 1970s song, "There's got to be a morning after." And for the markets and the economy, the mid-term elections and monetary easing decision from the Federal Reserve Open Market Committee will come and go, leading to a morning after and decisions to be made.
Some market pros already have their eyes on a fresh set of challenges that will arise once the Republicans stage their likely landslide and the Fed starts printing money again.
"Unlike what happened in the soft-patches of the mid-1980s and again in the mid-1990s, the economy today is just a shock away—even negative fiscal shocks—from slipping back into contraction mode," warned David Rosenberg, economist and strategist at Gluskin Sheff in Toronto, in his daily note.
Here is a fast list of five factors that will influence the market ahead:
1. A Trade War
In addition to aiming at getting more money flowing in the economy, the Fed's aggressive quantitative easing (QE) policies have hammered at the dollar and riled up some US trading partners.
Another round of QE isn't likely to sit well with those tiring of ballooning US debt and the nation's attempts to keep its exports cheap by weakening its currency.
"The risk that the markets are not fully appreciating is what happens if the Fed becomes very aggressive and heavy asset purchases cause further weakness in the U.S. dollar, which then touches off a currency war ...followed by a trade war?" Rosenberg asked. "The case for gold as a hedge against this more-than-remote possibility is pretty strong."
The US dollar is near a 12-month low against a basket of foreign currencies. While cheap money has helped fuel a stocks and commodities rally this year, a weak currency could undermine confidence in the economy both domestically and abroad.
2. Will Gold Keep Going?
As Rosenberg said, the debased dollar is helping boost a run on precious metals that looks pretty strong, especially considering the dollar movement. A weak greenback makes dollar-denominated commodities cheap that are purchased with more valuable foreign currency.
Michael Cohn, chief investment strategist at Global Arena Investment Management in New York, has been following a chart comparing the level of the Dow industrials to the movement in gold, and believes the metal has room to run for at least the next two years or so.
"What this chart is telling is we're probably within a couple years of the end game on the decline in equity valuations and the rise in gold, where you sell your gold," Cohn says. "It really says don't give up on gold yet. We could still have a ways to go there. Be careful with equities."
The inverse correlation between the two asset classes has been strong, particularly since the end of the gold standard in 1971, Cohn says.
3. Company Balance Sheets
Investors seem impatient for corporate earnings to take off the training wheels—that is to say, it's time to stop merely beating bottom-line forecasts but also to start showing strong signs of revenue increases.
In the third-quarter earnings season, about 83 percent of the Standard & Poor's 500 have exceeded estimates. That's about in-line with recent trends, but the move higher in revenue remains less apparent though finally raising some hopes.
One way to increase that confidence would be for firms to show they can operate without some of the heavy-handed government intervention present in the past three years.
"Investors are starting to make some money again and the attitude is changing a little bit in the marketplace," says Nadav Baum, executive vice president at BPU Investment Management in Pittsburgh. "My feeling is I'd like to see less intervention and let the markets do what the market's going to do and let these companies create value for shareholders."
Regulatory Landscape; History as Guide
Among the expectations when the new Congress takes overis more of a hands-off approach when it comes to regulation, particularly in the financial sector.
Financials, in fact, have trailed the September-October rally and are the second-worst performing sector of the S&P 500 over the past year, with a 1.06 percent gain.
Analysts are now beginning to ponder what a post-Democratic Congress will look like, with some focus on the credit card industry.
"We think that the political environment in Congress for the card industry should improve after the election," analysts for Keefe, Bruyette and Woods wrote in a research note. "Part of that is due to the fact that Congress has already accomplished its legislative goals and now it is up to the regulators to implement and enforce the laws that were passed over the past two years."
While KBW doesn't necessarily see a repeal of the Card Act, which imposed strict new regulations aimed at protecting consumers, "the prospect for additional negative legislation would drop, in our view, considerably."
5. Post-Election Cycle
The prospects for the type of legislative gridlockthat could come with a Republican landslide Tuesday are being hotly debated, but simple history may dictate the terms. The cycles after mid-term elections have been resoundingly positive for stocks, no matter who takes the reins.
"It may be that the market views a more even balance of power between the executive and legislative branches as reducing the chances of policy outcomes that a substantial portion of the electorate may view unfavorably," Brian Gendreau, market strategist with Financial Network in El Segundo, Calif., wrote in a detailed analysis of post-election market behavior.
"Prior to the elections the market prices an uncertainty or risk premium into stock prices. Once the elections are over and the outcome is known—for better or for worse—uncertainty has been reduced and the market takes the risk premium out of stock prices."
While Gendreau and others think the market may have been at work pricing in the Fed and election news, a significant move lower would be a sharp break with previous behavior.
"The possibility exists that the explosion of information about election races since the advent of the internet may bring forward much of the market’s response before the elections," Gendreau wrote. "But if no post-election bounce at all materializes it will represent a break with most of history."