At this writing, we don’t yet know the outcome of the big midterm elections. The polls and analysts are predicting a Republican takeover of the House and big gains in the Senate. Assuming they’re correct, there are some things that I expect to happen within a few months of this seismic political shift away from socialism and toward free markets. Here are a few at the top of the list.
The dollar will strengthen. Economists, government officials, commentators and politicians have many excuses for why the dollar has been so weak. Some think it’s our trade deficit. Some think it’s a fear of future inflation. Some think it’s a fear of another recession. Some think it’s the Fed printing too much money.
While all of these explanations have some merit, the most significant reason for a weak dollar is that investors have no confidence in this socialist government that has been running the United States for the past two years. Our trade deficit has been around for decades and has been worse at other times. Other central banks around the world are also printing money like crazy. If inflation were a real concern, Treasuries wouldn’t be trading at record low yields. As far as an economic collapse, if we go into another recession most of the rest of the world will as well. The only factor that sets us apart from other major countries is that America has been leaning toward socialism at the same time as most other countries are moving toward free markets. A strong Republican victory will signal a reversal of this trend, which should cause the dollar to strengthen.
For similar reasons that the dollar will strengthen, precious metals (e.g. gold and silver) will collapse. Precious metals are in an asset bubble that is completely detached from any fundamentals. This is particularly true for silver, which would be down 50 percent from where it currently is trading if not for the speculative frenzy driving the market right now. Gold would probably be 25 percent lower.
This speculative frenzy is driven not by a fear of inflation, which currently is dormant, but by a fear of the socialists running our government. The socialists have caused investors and traders to lose confidence in our currency, our economy and our markets. Precious metals are the ultimate safe-haven fear-based investment for people who have no confidence in our financial system or our country. Again, a strong Republican victory will go a long way toward mitigating these fears, which will cause money to flow out of a fear-based hideaway like precious metals and back into more productive investments.
Specifically, stocks should outperform all other asset classes over the next 12 months after a big Republican win. Stocks should benefit from several changes that will come along with a big Republican win. First, tax rates will stay low and maybe even in some cases go lower versus definitely going much higher under the current socialist regime. Second, regulations will be scaled back versus constantly being expanded. Third, foreign investment will increase because of greater confidence in our system. Fourth, high-net-worth investors and consumers will have greater confidence and willingness to invest in riskier assets and spend their money.
As stocks and the economy benefit, Treasuries should underperform stocks as well as other types of riskier bonds. Even though the Federal Reserve probably will continue to manipulate Treasury yields to be lower than they should be and thus also inflate Treasury prices, a stronger economy and more competition for private capital from stocks and other riskier assets should cause Treasuries to generate weak or even slightly negative returns for the 12 months after a big Republican win.
Longer term, unless the economy collapses again or the socialists take control of the government again, Treasuries could underperform for many years. Eventually, if the economy improves, the Fed will need to stop buying Treasuries and raise interest rates, which would put further downward pressure on Treasury prices.
Bonds in general will not be a great place to be in a pro-growth, pro-market environment. Municipal bonds may have similar underperformance problems because federal bailouts are less likely under Republicans and higher rates will make it even more difficult for financially insolvent states to borrow enough money to meet budget shortfalls.
Foreign government bonds will face similar issues to Treasuries. Agency bonds (i.e. Fannie and Freddie) also may struggle because of concerns that a more market-oriented government will not always be there to bail out these perpetually money-losing quasi-government entities. If you must stay in bonds, investment-grade corporate bonds are probably the least bad place to be. These bonds offer better yields than most any of the other categories of bonds except junk bonds, which are much riskier and deserve much higher yields than investment grade.
Small businesses, private investment and job creation will get back on track again. Corporate America has been sitting on $1.8 trillion of free cash because executives have been afraid to invest under this socialist regime. If corporations believe the government has stopped being their enemy and is willing to just get out of the way, that cash will start flowing into new investments. Jobs will be created. Small businesses will be created. Businesses will grow. Profits will go up. Wages and benefits will go up. Consumers will start spending again. The virtuous cycle of free enterprise will begin again.
Unfortunately, real estate still probably will be stuck in neutral regardless of the election. Real estate still is mostly overvalued. The changes that need to happen in the real-estate market probably can’t be handled even by a totally new, pro-market Congress. Fannie and Freddie need to be dissolved. Banks need to be forced to mark loans to the underlying value of the assets. A new version of the Resolution Trust Corporation needs to be formed to cleanse the system so that a new bull market in real estate can begin. Only a new presidential administration combined with a new Congress that is friendly to market reforms can make these large structural changes happen. Real estate probably will have to wait until 2012 for a real recovery.
Of course none of these positive changes can happen without a big Republican victory. For better or worse, Republicans are the best hope right now for getting the country back on track to prosperity. I’m not a diehard Republican. I’ll support anyone of any party who is the most free-market-oriented, pro-growth candidate. This year that generally means Republicans, especially with the strong influence of staunchly free-market tea-party candidates who are now included in the Republican ranks. Let’s hope for the good of the country and everyone in it that the midterms are good for free markets and bad for socialism.