The financial markets have reacted in a predictably negative fashion to the prospect of legal challenges to another U.S. presidential election. Bond yields, equities, and the dollar are all down, while gold is up.
This mimics the November-December 2000 reaction of financial markets to the election deadlock. But the reaction is occurring earlier in 2004 than it did in 2000 because markets learn from experience. In the 2000 election, the outcome (no declared winner) was completely unexpected and hadn’t been discounted. In 2004, the possibility of a contested election outcome is widely discussed, forcing markets to discount it in advance of the election.
Adding to the normal election volatility is the broader evidence of U.S. litigiousness and its direct connection to asset prices. The risk of electoral litigation is huge. The insurance industry is under investigation, hammering those stock prices. Ads for Vioxx-related class-action lawsuits are already hitting the airwaves, emphasizing the efficiency, productivity, size, and profitability of the litigation industry.
In 2000, the market reacted very badly to the election crisis. In the five weeks between Election Day and the resolution in the Supreme Court, the 10-year bond yield fell 53 basis points. The Nasdaq fell 24 percent from November 7 through November 30, 2000. This reaction also reflected the looming recession; technically, it started in March 2001, though revised data show negative results for the third quarter of 2000 and the first and third quarters of 2001.
If either President Bush or Senator Kerry is declared the winner on November 3, bond yields, the dollar, and equities will rise initially and gold will fall, undoing the risk discounting that is going on now. And when a presidential winner is declared, attention should shift to the Senate races.
A Bush win with the Republicans adding two or more Senate seats from the current 51 would favor stocks and disfavor bonds on the view that Bush might make progress on pro-growth tax and Social Security reforms. Other scenarios would probably cause less change in the outlook and markets. Polls show four possible Democratic takeovers in the Senate (Alaska, Colorado, Illinois, and Oklahoma) and six possible Republican takeovers (Georgia, Florida, North Carolina, South Carolina, Louisiana, and South Dakota).
If Bush wins all the states he won in 2000 except New Hampshire (where he is trailing), the electoral college result is 274-264 in favor of Bush versus 271-266 in 2000. (The total is normally 538, but one D.C. delegate left a blank ballot in 2000.) The census changes favor Bush states in the 2004 electoral college, more than offsetting the expected loss of New Hampshire’s 4 electoral votes. In 2000, Bush won Ohio and Florida, but not Pennsylvania. Some current polls show the same result this time.
So, if election-night returns allow a winner to be declared, then litigation won’t be critical to the outcome. However, if some key states have a very close vote count, the formal electoral-college decision and litigation relating to it will affect or control the outcome.
After the November 7, 2000, election, Florida didn’t certify its electoral votes for Bush until November 26. Florida courts challenged this. The U.S. Supreme Court decided on December 12 that there was no time to conduct a recount, ending the challenge. Gore conceded on December 13. In 2000, the U.S. Supreme Court also decided 7-2 that there is a constitutional right to have each ballot counted in the same way (though it decided this wasn’t possible in 2000). This creates room for new litigation on voting processes in many states. The Colorado (9 electoral votes) referendum on splitting its electoral-college vote looks unlikely to pass, but if it does, litigation there could also be critical.
In the end, someone will be president and the constitution will be preserved, meaning the damage from another election crisis, while potentially large, isn’t unlimited. And while a weak-dollar trend is the biggest market risk in an election crisis given the leveraged position of the U.S. and the momentum nature of currency movements, statements and action by the Federal Reserve could stop a sharp, inflationary decline in the dollar.
– David Malpass is the chief economist for Bear Stearns.