Election results hold out hope for change

Today's October ADP private sector payroll report didn't change the economic outlook, but I still think the economic fundamentals are gradually improving. Job growth, as estimated by ADP, was marginally higher than expected (+230K vs. +220K), but as the chart above shows, that's within the range of what we have seen for the past several years. We would need to see numbers of +250-300K or more before getting really excited about a stronger economy.

The October ISM service sector report (first chart above) was OK, but the employment subindex (second above) was the highlight: a significant gain, of the sort we rarely see. This speaks to an improving level of confidence in the future, and that is one ingredient that has been sorely lacking in this recovery. As the third chart shows, the U.S. service sector continues to outpace that of the Eurozone, but neither one shows any meaningful deterioration.

Nevertheless, even relatively lackluster numbers like these carry an important measure for investors who are uneasy about holding cash: as long as the economy avoids recession and continues to grow, risk assets are likely to outperform cash since they carry yields which are significantly better than the zero yield on cash.

Meanwhile, yesterday's election results offer real hope for the future. The so-called Republican "wave" was not only a repudiation of Obama's liberal agenda and his anti-growth policies (e.g., Dodd-Frank, Obamacare, anti-carbon agenda), but also of his failed leadership and his aversion to bipartisan reform. If anything is to get done in the next two years, it will need to have bipartisan support. I'm pretty sure the Republicans understand that, and Obama will find it hard to veto bills which represent the newly expressed will of the country.

At the very least, a Congress at odds with the President means that federal spending is likely to remain subdued; taxes are highly unlikely to rise (the current burden of taxation is intolerable, but it surely is not going to get worse); there is a decent chance of some reductions in tax rates (especially for businesses) accompanied by some simplification of the tax code; and some growth-oriented measures (e.g., Keystone pipeline approval, market-based reforms of healthcare, reductions in employer mandates) have a good chance of passing. Any or all of these would act to convert headwinds into tailwinds, restore confidence, and boost optimism. A Republican Congress could be the best thing to happen to Obama's otherwise failed presidency.

Speaking of confidence, the ongoing decline in the price of gold confirms that the world is becoming less risk averse and gradually more confident. The declining price of 5-yr TIPS (using the inverse of their real yield as a proxy for their price) also reflects less risk aversion. These are very important indicators to watch. Further declines in gold and TIPS prices would bolster the bull case for markets and the economy.

Posted by Unknown

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