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Posted on June 19, 2008 -
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By John Reizner |


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I would like to draw your attention to the following web page graph denoting the Presidential futures market vote shares between Democratic and Republican candidates in the upcoming 2008 Presidential Election (as expressed in the Iowa Electronic Markets - a respected election futures market): 

http://iemweb.biz.uiowa.edu/graphs/graph_Pres08_VS.cfm.
 
This shows a potential Obama victory in the Presidential election, as the Iowa Electronics Markets has a good record at predicting election outcomes.

I believe a potential Obama Presidency, given many of the policies that have been proposed by the Obama camp and by others in the Democratic Party, may hinder the economy's flexibility, competitiveness, and productivity - strengths that may explain why the American economy has been able to withstand many past economic shocks without fundamentally faltering. Notably, Alan Greenspan observed in a past speech that the flexibility of our economy was related to having less economic regulation of industry.
 
Joseph Schumpeter's theory of the new supplanting the old, or "creative destruction," is meaningful here. For example, it might not be a good idea in many cases for an Obama administration to "bail out" failing companies as these companies may produce obsolete products, use outmoded manufacturing techniques, or just be globally non-competitive (no one wants to buy their products). If our government does not bail out failing companies, then risk takers will have the opportunity to establish companies that use new technology or that produce products in high demand. Also, it may be better to have workers from older industries retrained for the emerging jobs of up and coming companies.
 
Further, higher taxes on risk takers, taking money from one group of wealth producers and giving it to another less productive group (the redistribution of wealth, sometimes embraced in left-wing countries), and the proposed gutting of free trade (the renegotiation of the NAFTA), may lower the level of confidence in the American economy here and abroad. Capital outflow from the United States from the investor class could begin in earnest. It is even possible down the road that Obama could be convinced, because of the outflow of capital from the US, to place capital controls on the movement of money, a move that might be a body blow to our stock market and the dollar. It is also conceivable that a run on the dollar could propel an Obama administration to place restrictions on US citizens on the flow of their money.
 
I have written about the importance of the level of confidence behind the scenes in the economy and the markets in my article, The Level of Confidence in the Stock Market and Our Social Contract, posted on my website on October 1, 2007. Without confidence, there is nothing to hold the stock market up. An example of this was in the aftermath of the October 1929 stock market collapse, when poor policy choices caused much suffering among the public and businesses (the Federal Reserve shrinking the money supply, tax increases, the Smoot-Hawley trade tariffs of 1930, and the wholesale liquation of debt). A loss of confidence in the stock market and the economy ensued and persisted for years. Should Obama win in late 2008, and should he make poor policy choices, the stock market may proceed into a 1970's style decline. As a result of this potential destruction of wealth, investors and the economy may be in for real difficulty.
 
I have been writing about the 1970's style inflation in our economy in my article blog for over a year. We already have an embedded inflationary economy which I believe may worsen over the next few years. Also, recent Federal Reserve easing to combat the credit crunch / subprime crisis may likely filter through the economy, perhaps lifting inflation dramatically. I also believe that as this inflation takes further hold, interest rates may climb.
 
A rejuvenation of the unenlightened policies of the 1970's and even from the 1930's may cause a contraction in the price earnings ratio of many stocks (many stock prices may decline) in the market as well as a continuation of a higher inflation economy. I first wrote about this contraction of P/E ratios in my January 18, 2008 article, The Stock Market and the Economy: A Return to the 1970's in Form? We have already witnessed a 15% decline in the stock market.
 
Some sectors of the stock market may resist the decline of equity prices. I plan to hold onto my oil, oil service, and railroad stocks, along with certain industrials and my gold position. The oil companies may be hit by a windfall profits tax, which may result in less oil being produced. Excess regulation in this area and the railroad sector would be a cautionary factor for these stocks. I also have some large cap growth companies which are already doing well: Anheuser Busch, Wal-Mart, and Johnson & Johnson (all Warren Buffett holdings). I will maintain these. I also continue to hold a position in the Templeton Global Bond Fund.
 
If the general market turns down, most stocks, even the best groups, may move downward. However, I believe the resource and materials (inflation-hedge) stocks along with the price of gold may recover and surmount their highs as inflation may be hard to contain. With the higher inflation I foresee, the economy may in time need to be stifled by high interest rates and tight money to cure the inflation disease-just as Paul Volker's Federal Reserve in the early 1980's put a monetary stranglehold on the economy after the high inflation of the 1970's.
 
I am going to continue to watch the Iowa Electronic Markets for clues about the election outcome. As far as my remaining stock portfolio, I am going to look at stocks to sell that may be badly bruised by an Obama market. Perhaps cash will continue to be king for now as we proceed through the unwinding of this credit crunch and the beginning of a possible ultra-liberal administration. 

 

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