A Republican Victory in the US Midterms Is a Plus for Japanese Stocks

The U.S. midterm elections this Nov. 4 constitute the last remaining big political event of the year. The president will not change, so there will be no major shifts in policy trends, but some sort of reform will be inevitable following the results of the elections. This article examines the influence these midterm elections will exert upon the economy and stock market.

As it happens, there is a strong overall corollary to be observed between presidential election cycles and the stock market. Before delving into the main topic, it would be helpful to understand this pattern.

U.S. Stocks Are Strong the Year Preceding Presidential Elections

There is a well-known anomaly in the American stock market: Stocks are strong the year before presidential elections. An anomaly is a phenomenon that occurs frequently, but has no clear cause.

Say one separates each year into four categories: a presidential election year, a following year, the year after that (the midterm elections year) and a presidential election run-up year. After averaging the historical growth rates of the Dow Jones Industrial Average (hereafter referred to as Dow) in each year category, the category with the highest average growth is the presidential election run-up year. It is safe to say that U.S. stocks are indeed strong the year before the election.

It hasn’t always been this way. From 1897 to 1931, the run-up year was second weakest after the midterm elections year, on average. However, if the observed period is restricted to 1932 onward, average growth jumps to 16.2 percent: The strength of the run-up year becomes strikingly obvious.

Yearly average growth isn’t always high, but of the pre-presidential election years since 1932, only one year experienced net negative growth: 1939, the year in which World War II broke out. Even the market of 1987 — the year of Black Monday — rose by 2.3 percent by year’s end. This was due to the fact that despite the high return of American stocks on pre-presidential election years, they are also low risk. What could possibly have happened in 1932 to cause this?

Keynesian Economics Boost U.S. Stocks in Pre-Presidential Election Years

At the height of the Great Depression in 1932, the Democratic candidate, Franklin D. Roosevelt, defeated President Herbert Hoover, the Republican incumbent. Immediately upon assuming office, President Roosevelt initiated a series of bank relief measures and public works projects collectively known as the New Deal, which steered the American economy toward recovery.

Up until that point, U.S. economic policy consisted of a “leave it up to the people” sort of laissez-faire liberalism, but under the New Deal, “the government will proactively participate,” “government must support business during recession,” and other such Keynesian policy concepts were swept into the administration.

I think these Keynesian policies are what caused the strong stock anomaly to appear after 1932. Administrations want to be able to meet presidential elections in favorable economic conditions. Since policy may not take effect in time were it to be implemented directly before an election, economic policies are carried out up to a year in advance. This creates a favorable impression (anticipation), and U.S. stocks rise as a result.

Since next year (2015) is a pre-presidential election year, according to past experience it is safe to expect a strong showing from the U.S. market.

The Question Is the GOP’s Ability To Claim Senate Control

Now to the main topic. In the current U.S. Congress, the Democrats control the Senate and the Republicans control the House — a so-called “twist.” Since the Republican Party will almost certainly maintain its majority in the House, the question is whether or not a GOP upset is possible in the Senate.

Real Clear Politics, a U.S. website that issues election predictions based on aggregates of public opinion polls, has predicted for the Senate races a perfectly even 45 seats to the Democrats and 45 seats to the Republicans, with 10 seats uncertain. (As of Sept. 10, this includes seats not up for re-election).

There is a common trend toward the opposition party picking up seats in midterm elections. Another factor to add to the GOP’s tailwind this time around is President Barack Obama’s unpopularity. According to a Gallup opinion poll, President Obama’s approval rating is at 40 percent, in contrast with a 53 percent disapproval rate — a tie with his lowest-ever rating (from a study conducted between Sept. 1 and 7).

The health care reforms (Obamacare) that finally reached full implementation last year have a bad reputation. Other signature policy proposals, like immigration reform and gun control, have gotten almost nowhere due to Republican opposition.

In foreign matters as well — the regional conflicts in Syria, Ukraine and Gaza, for example — the United States’ inability to show leadership has invited deterioration of American dignity. The resulting unpopularity can’t really be helped. However, since there isn’t strong support for the GOP either, the Senate battles are certain to be a close contest.

Provided the Democrats are able to maintain their majority in the Senate, things will remain as they have been. However, if Republicans wrest control of both parts of Congress, it’s a safe bet that there will be a change in American politics and policy.

From here, I’ll take a look at what can be expected in the event of a GOP victory, as well as the subsequent effect that would have on business and the stock market. My three main points of interest are the following: resolution of the “politics of indecision”**; moving from an “inward-facing” to an “outward-facing” foreign policy; Trans-Pacific Partnership (TPP) negotiations.

How To Resolve the “Politics of Indecision”: U.S. Edition

Japan doesn’t have the patent on the “politics of indecision.” The U.S. government is also well on its way to an indecisive government of its own. As stated above, Obama’s signature legislation proposals are at a standstill, and the airstrikes on Syria promised at one point last year were never carried out. Last October, due to gridlock, Congress failed to pass a provisional budget and the government was shut down. This is the most extreme possible indicator of a government that can’t make a decision.

People have the impression that the president has a great deal of power and can decide anything quickly in the U.S., but this is mistaken. In fact, the structure [of U.S. government] is even more in danger of falling to the “politics of indecision” than Japan’s.

In America’s policy-making process, Congress first decides on a bill or budget (and to accomplish this, the Senate and the House must be in agreement). The president then approves (or vetoes) the proposal. Without Congress’ approval, nothing moves forward. Congressional dysfunction due to a “twisting” of the houses is the No. 1 cause of indecisive politics.

In Japan, it’s possible to push through legislation if the ruling party occupies two-thirds of the seats in the lower Diet. Similarly, the lower Diet has supremacy in budget matters. There is no such system in the U.S. In addition, since Congress can’t be dissolved, the president can’t use threat of dissolution as a weapon in order to force a compromise.

Obama’s lack of leadership is another factor. For a president with high public support, it’s possible to act as a mediator between the parties and press for compromise, but the Obama of today lacks that sort of power.

However, if the GOP controlled both chambers of Congress, decision-making will cease to be such an issue. Since the president is a Democrat, it’s not likely everything will pass with no objection, but surely it’ll be easier to find common ground than it has been up until now.

It’s good news that the so-called tea partyers — the conservative diehards that have been the main culprits behind gridlock — are losing their influence in primary elections. I think that as the voices of Republican moderates become stronger, the U.S. will be able to take a step towards resolving their “politics of indecision.”

Perhaps sensing weakness, American business prospects are favorable and American stocks are on the rise, even as the government talks in circles. However, it would seem that the sense of unpredictability toward policy is a factor for restrained consumption at the individual level, and restraint in capital expenditure and mergers and acquisitions at the corporate level. If this sense of unpredictability in politics and policy can be erased by resolving a “twisted” Congress, that should remove this cause for restraint. This could only be a plus for business and the market.

From “Inward-Looking” Policy Toward “Outward-Looking” Policy

Obama’s administration has favored an “inward-looking” sort of foreign policy. By 2011, the withdrawal of U.S. troops from Iraq was complete. Since then, the U.S. has similarly avoided any sort of proactive involvement in regional conflicts like those in Syria and Gaza. Regarding Asia, there has been no sort of clearly identifiable stance toward China’s continued development. This sort of inward-looking policy is a reflection of war-weariness among the American public due to the prolonged engagements in Iraq and Afghanistan.

However, recently there have been a few changes to this inward-facing posture. While continuing airstrikes on bases held by the Islamic State — the extremist Sunni faction in Iraq — in Somalia, the U.S. assassinated the leader of al-Shabab, an extremist group connected to al-Qaida. In addition, the U.S. is currently calling upon members of the “coalition of the willing” to aid in dealing with the threat of the Islamic State group.

Obama’s recent shift from “inward-looking” to “outward-looking” has not only been driven by complaints from the GOP and the media, but also from the American citizenry, which has been increasingly critical of Obama’s prudent posture. Recently in public opinion polls conducted by The Washington Post and ABC, 71 percent support the airstrikes on the Islamic State group, 65 percent support expansion to airstrikes on Syria and 53 percent think that President Obama is “too cautious” in diplomatic matters.

It would appear as though the generally hawkish GOP would be likely to pursue more aggressive involvement overseas if they manage to secure a majority. While it’s clear that the U.S. isn’t as strong as before, as can be seen from the call to arms to the coalition of the willing, there is no one besides the U.S. with the leadership to oppose the Islamic State group.

Provided the U.S. continues to shift its foreign policy from “inward” to “outward,” it seems likely that it would help restrain the expansion of geopolitical risks. This, in turn, is predicted to help business and stocks grow, as well as cause a fall in the price of crude oil.

A GOP Win Will Mean Progress in TPP Negotiations

To wrap things up, the TPP negotiations are of principle interest in terms of how Japan will be affected. Since it’s been said from the start that not even a tentative agreement could be reached before the midterm elections, it seems that when midterms are over negotiations will pick up again. A Republican victory may result in a speeding up of the talks.

It’s said that the GOP, which generally favors small government and free trade, has a more proactive attitude about the TPP than the labor union-sympathetic Democrats. This is the reasoning behind anticipating greater developments in TPP talks in the event of a GOP win.

Of particular importance is the bestowal of the executive Trade Promotion Authority (TPA), also known as the “fast track negotiating authority.” In the United States, Congress is endowed with the power to enact foreign trade agreements. Even if the administration ratifies a trade agreement with a foreign state, there is a risk of needing to negotiate from scratch to include revisions in the event of a clause that Congress dislikes.

However, if the president obtains TPA approval from Congress in advance, Congress loses the ability to disrupt ratification over each and every clause, and foreign countries may rest assured in conducting negotiations with the U.S. (ratification requires unanimous consent from Congress).

Obama is seeking TPA authorization from Congress, but has so far been denied. Rather than the Republican opposition, it is fellow Democratic congressmen who are resisting.

It’s worth pointing out that one reason for stalls in TPP negotiations is that foreign countries feel some hesitance in negotiating with an America that can’t renew the TPA. It seems that if the Republican opposition was able to acquire a majority in both the House and the Senate, a TPA renewal could be expected and the chance of TPP negotiations moving along would increase. In such an event, surely it’s reasonable to think it’d be a boon for stocks and business — particularly Japanese stocks.

Based on the above points, I think that a Republican win in the midterm elections would prove to be a plus for the U.S. and Japanese stock markets.

*Editor’s note: “ねじれ” (nejire), referring to “ねじれ国会” (nejire kokkai, or “twisted Diet”), is a Japanese political term for when the two chambers of the Diet are controlled by different party majorities. Japan’s Diet has been in this situation on and off for a total of nine years since 1998.

**Editor’s note: “決められない政治” (kimerarenai seiji, or “politics of indecision”) is a term used to describe the stagnant, unproductive state of Japanese politics.