Valliere: What Could Change the Election Outlook?

From now until Nov. 2, everything coming from Washington will be aimed at the crucial House and Senate elections, which have the potential to be a tsunami, like the one in 1994 that swept Newt Gingrich to power in the House.

If the election were held today (it won’t be), the Republicans would take control of the House; they need 39 net seats and something like 45 looks likely. The magic number in the Senate is ten, which seems like a long-shot; a GOP pickup of 5-to-7 seats seems probable there.

As I have written here previously, the magnitude of the Republican gains – whether or not they take either house – will be sufficient to end the government activism that prevailed over the past two years. Gridlock will prevail in 2011-12, which in general is a good thing for the markets.

With only three and a half months left until the election, could anything change this dismal outlook for the Democrats?

There are three wild cards:

The economy: If anything, the outlook has worsened. Everyone we talk with has lowered second half GDP projections, and it’s entirely possible that the fluky 9.5% unemployment ratefor June will inch higher, not lower, in the next couple of months. A dramatically higher stock market this fall could help the Democrats, but the economy is looking like an enormous albatross for the party.

Geopolitics: An “October surprise” has altered many elections, but usually in favor of the more hawkish Republicans. It’s difficult to see how a blow-up in the Mideast or anywhere else could be a major plus for the Democrats, who are increasingly dovish on issues such as Afghanistan.

Go negative: By default, this appears to be the best chance the Democrats have. From President Obama on down, the rhetoric will turn fiercely partisan, charging that the Republicans are in bed with big business, favor tax cuts for the rich, and agree with extremist policies that some Tea Party members favor, such as elimination of Social Security and Medicare. Most Republicans favor those programs — but if they don’t distance themselves from the Tea Party, they will be tarred with that brush.

Presidential speech pedistal
Photo by: Pete Souza
Presidential speech pedistal

There could be other wild cards – scandals, gaffes, hurricanes, etc.

But it increasingly appears that the die is cast, that the Democrats will suffer huge losses.

This will raise an intriguing question: post-election, will Barack Obama dig in his heels and risk becoming a one-term president, or will he move toward the center, as Bill Clinton quite successfully did?

My sources say that in private, Obama has told his aides that he’s perfectly willing to be a one-term president in exchange for enacting an activist agenda – health insurance, financial services reform, etc. If unemployment is still above 8% in 2012, he may be prophetic.

The Democrats are in real trouble, and they were loudly squabbling in public this week. But going negative almost always works, so you can be sure Obama will furiously play his strongest card – demonizing the Republicans.

Greg Valliere is Chief Political Strategist at the Potomac Research Group, a Washington-based firm that advises institutional investors on how government policies affect the markets. Greg has covered Washington for over 30 years, starting his career as an intern at The Washington Post, then co-founding The Washington Forum in 1974 to bridge Wall Street and Washington. He has held several positions, including Director of Research, for Washington-based firms, including the Schwab Washington Research Group. Greg is an exclusive commentator for CNBC-TV, where he appears regularly on most of the network’s programs.