Ramifications of Republican Romp

In our recent midterm election preview, we said that Republicans were likely to gain control of the Senate in a close contest; we also laid out some possible implications of such a win. As it turns out, we did not give the Republican momentum enough credit, as election night turned out to be a clear victory for the GOP across the board. A few contested races are yet to be determined; however, it would appear that Republicans will pick up nine net Senate seats (six were needed for control) and enough net House seats to gain the biggest GOP majority there since the Great Depression. In perhaps the biggest surprise of the night, Republicans won virtually every tight governor’s race, including the blue strongholds of Illinois, Massachusetts and Maryland.

Having run a campaign centered on repudiating the president and his agenda, will the newly empowered GOP embark on a path of confrontation? We don’t think so. Amidst all the Washington rancor and dysfunction, we still see “green shoots” of room for compromise on the core issue of tax reform. However, the devil is in the details, and there is still risk of a far less constructive outcome. The primary economic risk from conflict across the aisles would be a reprise of the debt limit showdown. The current debt limit suspension will end in March 2015, and a debate over fiscal matters could devolve into another shutdown next summer.

While we cannot completely discount such an outcome, we think that chances are very low. The broader backdrop to political posturing over the next two years will be the 2016 presidential election. While some mavericks may operate outside the party playbook, practicality would suggest that a shutdown would severely damage GOP prospects. Polling indicated that the public overwhelmingly blamed the last shutdown on Republicans. GOP leadership will think twice about stepping on that landmine again in the lead-up to 2016. Additionally, the level of U.S. fiscal stress has abated quite a bit. Budget deficits fell from 10% of GDP in 2009 to a run rate of under 3% in 2014, reducing the urgency of a fight for austerity.

If there is a risk to increased hostility, it stems from a potential showdown over immigration policy. Unilateral executive action on immigration might ignite a spiral of political conflict that could be damaging to the market backdrop. A potential path for the president would be to pursue an up/down vote in Congress rather than executive action. Such a vote would maintain a push on the issue (and a spotlight on a potential GOP weakness) without creating undue blowback. This is a wild card worth watching closely.

As we touched on in our election preview, we see the changing political landscape affecting a number of industries as well as setting the stage for progress towards comprehensive tax reform. In brief, some impacted areas include:

Financials: The sweeping GOP victory should create a less hostile regulatory backdrop for many financial services firms. We are likely to see a congressional push for structural change at the Consumer Finance Protection Bureau (CFPB). The focus would be on creating a panel of commissioners rather than a single director, as well as changes to incremental rule-making process. Another expected push will be to alter the Dodd-Frank Systematically Important Financial Institution (SIFI) designation rules to exempt smaller banks and non-bank institutions.

Healthcare: While we do not expect a sincere effort to repeal Obamacare, we do anticipate concerted efforts to modify it around the edges. While funding issues remain, medical device tax repeal odds have increased. Reimbursement changes might weigh on hospitals with bad debt problems.

Tax reform: Corporate tax reform will soon move to the fore. The parameters are falling in place with a reduction in corporate tax rates balanced with closing of loopholes and modifying/deferring tax preference items such as R&D costs, accelerated depreciation and LIFO accounting. In addition, the likelihood of a repatriation policy (something like a one time, single-digit tax on overseas cash) as a path to pay for infrastructure spending has increased. Overall, these changes would be earnings positive for U.S. corporations, but the details of what loopholes would be at risk will be key.

Overall, we see the political backdrop as incrementally positive for the markets looking forward as both political parties begin to position for the 2016 elections. With positive, but modest economic growth as the U.S. backdrop in an uncertain world, it would seem likely that politicians will be wary of actions that might impede growth in advance of the presidential contest. Historically, the period we are entering has, on average, been a market-friendly environment, perhaps for these reasons.


Source: Strategas. Past performance does not guarantee future results. It is not possible to invest directly in an index.


The views expressed are as of 11/10/14, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts are accurate.

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