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The Catalyst for the Markets

During the 1992 presidential election, when Bill Clinton was running against George H.W. Bush, the Clinton campaign coined that now-famous political mantra, “It’s the economy, stupid.”

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Jeffrey Coolidge | Iconica | Getty Images

We obviously don’t have a presidential election this November, but that pretty well sums up the situation right now as we head into the final third of the year. Economic news dominates both the markets and politics.

A fragile economy is obviously important at any time, but it takes on a higher degree of urgency when elected officials have to face the voters who put them into office. That’s where we are right now, and I think we are entering a period where there will be nothing more important to the markets than the November 2 midterm elections.

The chatter around the upcoming elections is only going to pick up steam. You think it’s a big topic now? Well, just wait until after Labor Day when the A-team returns to Wall Street and the fall campaigns get under way in earnest.

There have already been some surprises in primary elections. As I’m sure you've heard, one of the big stories right now is the possible defeat of incumbent Alaska Senator Lisa Murkowski by Joe Miller, a previously unknown Tea Party candidate endorsed by Sarah Palin. (They’re counting absentee ballots, so the result is still in doubt.) Sen. John McCain had to fight hard to hold his party’s nomination in Arizona, and prominent incumbents such as Bob Bennett (R-Utah) and Arlen Specter (D-Pa.) were defeated in primaries earlier in the year.

Most observers expect Republicans to pick up seats in Congress. But the decisive question is: Will the GOP gains be enough to take one, or maybe even both, houses on Capitol Hill?

Right now, CNBC’s Washington team puts the odds of a Republican-controlled House at 50-50 or better, and somewhat less than that for the Senate. If the GOP does gain at least one chamber, it will give the party an effective veto on the Obama administration’s legislative plans come 2011.

I was speaking the other day to a top money manager who told me he’s been selling equities lately, but said he’d probably slide back into the market if it becomes clear the GOP will control one of the national legislatures next year. The thinking in the investment community generally is that “divided government” will leaven the more aggressive impulses of the administration and Congressional Democrats and bring some needed balance into economic policymaking. In fact, markets historically do best under such divided government scenarios. Think: the post-2004 Clinton years, when the GOP controlled at least one side of Capitol Hill.

I don’t think we can overstate the importance of these elections and their potential impact on the markets. A lot is sure to happen between now and November 2, and we will be following it closely for you here on CNBC and in Investor Brief.

Questions? Comments? Write toinvestoragenda@cnbc.com