So far, the presidential election has not impacted stocks, but that could change if Mitt Romney appears unlikely to make it as the GOP nominee.
For the past several days, Romney’s vulnerability to former House Speaker Newt Gingrich has been the talk of trading rooms.
Gingrich beat Romney handily in the South Carolina primary Saturday, the second of three early contests that Romney lost. But the volatile Gingrich is not viewed as a strong candidate to beat President Obama.
“Obama’s gone from 50 percent probability to 55 percent on Intrade,” said Dan Clifton, Strategas head of policy research. “This week he just kind of exploded once Gingrich won in South Carolina. The Intrade market is saying there’s a much greater chance of President Obama being re-elected.”
Anxiety has been building on Wall Street about who will challenge President Obama, who gave a confrontational State of the Union Address Tuesday night.
Romney, the former governor of Massachusetts, is by far the preferred candidate on Wall Street, where many disagree with Obama’s policies and have been stung by what they call “class warfare.” Romney's supporters believe he supports more business friendly policies that will create jobs and support the stock market.
“I don’t think it’s fully reflected in the market yet," said Art Cashin, UBS director of floor operations. "There’s a mild degree of anxiety, and that’s really because it’s overbought. Is there a gentle longing for a smoke-filled room? Yeah. There’s some yearning for that.”
The S&P 500 was lower Wednesday after breaking its five-day winning streak with a slight loss Tuesday, but it is up more than 4 percent since the start of the year.
Analysts believe if Romney loses the Florida primary next Tuesday, he will have a hard time stopping Gingrich’s momentum. The latest Quinnipiac University poll, released Wednesday, shows Romney just slightly leading Gingrich among Republican primary voters in Florida, and that Gingrich's South Carolina win helped him narrow the lead.
Romney had support of 36 percent of the primary voters in the Florida poll, versus Gingrich's 34 percent. Gingrich, however, led Romney by 6 points among voters polled after the South Carolina vote, while Romney had an 11 point lead before the weekend vote.
“The two risks are the Romney candidacy just starts to flounder, and he’s not the candidate, and the other is if you get this kind of malaise in the Republican party long enough, it would invite in a third party candidate, a Ross Perot-type that would splinter the whole thing,” said Jack Ablin, CIO at Harris Private Bank. “Those are the two risks and I think the market is worried about those risks.”
“I would put those risks in the second half, but the longer this is really floundering, the more intense this could be,” said Ablin.
Barry Knapp, head of equities portfolio strategy at Barclays, said Florida could be an important key for both the race and the market, which Barclays' analysis shows has been volatile during primary season.
“If Romney closes the gap then this race goes on until the end of March, if not longer,” said Knapp. “I think if Romney loses decisively, and it looks like it’s going to Gingrich, then my sense is that it would be a volatility increasing event.”
“My general sense is that most people would view Gingrich as a much higher beta candidate. While things might go very well for the Republicans, they could also go very wrong,” he said. Knapp said his analysis shows that after primaries, the market’s focus on elections usually enters a lull until the party conventions in late August.
Cashin said the stock market is not yet focused on the election, but traders Wednesday were chatting about concerns that the president's State of the Union comments may mean his Administration could get tougher on financial companies. The XLF financial sector ETF was down just slightly Wednesday.
"I think you’re just seeing the first clouds starting to loom. Certainly if Florida goes (to Gingrich), it will get into far more of the conversation. I think now the market is guessing that Obama has a very good shot at getting re-elected," Cashin said.
As expected, Obama's State of the Union speech highlighted a number of domestic economic proposals, focused on jobs and the tax code. Obama, during the speech, said the wealthy should pay their fair share of taxes, and he called for a minimum 30 percent effective rate on millionaires.
Romney, earlier Tuesday, released his tax returns for 2010, which showed he paid a 14 percent effective tax rate after giving $3 mllion to charity. Most of his $21.7 million in income was made from investments.
In an interview Wednesday with CNBC's Larry Kudlow, Romney said Obama's tax proposal was "designed to come at me if I am the nominee."
Romney also disclosed Tuesday that he had a Swiss financial account that was closed in 2010 and that he made income from overseas investments. Romney, the founder of Bain Capital, has been criticized by Democrats and his GOP rivals for not releasing his tax return sooner, but now he faces criticism for his use of the tax code.
Clifton said while he agrees a Gingrich win next week could unsettle markets, it may be short lived.
“The establishment in the Republican party is in panic over the chance of Newt Gingrich becoming the nominee. They believe this is bigger than the presidency. There’s the idea it could take the House down and may make it harder to take the Senate," he said.
For that reason, Clifton said the party may try to field a new candidate to jump late into the primary races or to do a brokered convention, which would be very difficult. Names that have been floated are Indiana Gov. Mitch Daniels, who gave the Republican response to Obama Tuesday, and New Jersey Gov. Chris Christie. Both have said they are not running.
Clifton said that, ultimately, Obama’s re-election may have more to do with the stock market, since his odds on the prediction market, Intrade, correlate closely to the S&P 500. "The market would be saying there's a much greater chance of President Obama being re-elected," said Clifton, pointing to the chart of the S&P and Intrade odds (see above).
Peter Vanderlee, portfolio manager with Legg Mason's ClearBridge Advisers, said he does not think the market is ready to react to the election yet. "We're talking about a candidate that could be running against the incumbent president," he said. "It's a little early."
"I'd say toward the latter part of the second quarter, the market is going to pay more attention to what the candidates are proposing. The market knows this is an election," he said.
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