Midterms – A Love Letter to Texas

You know you’ve had a good sports weekend when you spend thirty minutes googling your coach’s contract situation to figure out the likelihood he gets fired.  And an even better weekend when you realize he’s still owed like $30mm and not going anywhere.

Last Week This Morning

• 10 Year Treasury steadily climbed all week to 3.22%
  • German bund up to 0.42%
• 2 Year Treasury rose 10bps to 2.91%
• Economy added 250k jobs vs forecasted 200k
• UR unchanged at 3.7%
• Average hourly earnings (read: inflation) 3.1%, highest since April 2009
• Consumer Confidence hit 18 year high
• Reverse QE aka Balance Sheet Normalization hit the one year mark and is now set to reduce Fed balance sheet by $50B/month
  • Balance sheet has shrunk $321B since last October and now stands at $4.1T
• Texas pulled a Penn State and gave away a game late in the fourth quarter
  • You may want to try PSU’s approach with Michigan next time, it really freed up the afternoon

Jobs Strong Like Bull

The economy added 250k jobs last month, well above the consensus forecast of 200k.  Last month’s report was revised upward by 16k jobs, bringing the three month average to 218k.

Take this report with a grain of salt, however.  Last month’s gain was just 134k because of the impact of Hurricanes Florence and Michael.  This month’s report was a make up from that weakness, so the truth probably lies somewhere in between.  In other words, still a strong report but maybe not quite as gangbusters as it seems at first.

The real story is the Average Hourly Earnings, which came in at 3.1% (as expected) – the highest since April 2009.  This type of inflation leading indicator will likely keep Powell & Co on track for a hike in December.

Midterm Elections

I always get the most hate mail when I touch on politics, so let’s see how many Texans I can upset.  That last part is not a joke.  Literally every piece of hate mail I have gotten over political newsletters has been from Texas.  Without exception.  Who knew Texans had such an affinity for Manhattan billionaires?  I’ve made jokes about Texas football – crickets.  But I make one joke about Trump and the inbox gets flooded.  And when I travel to Texas, I get along great with everyone! I love Texas!  But apparently Texas doesn’t love my newsletters.  Someone will probably email me and tell me I’d fit right in in Austin.

Base Case Scenario – Democrats Win House and Republicans Retain Senate

FiveThirtyEight has an 85.3% probability that the Democrats take control of the house, not factoring in the millions of illegal votes that will undoubtedly be cast.  Since the market is fully pricing in this outcome, the immediate impact should be limited.  Longer term risks are highlighted below.

Subpoenaorama – Dems will likely launch more than 100 formal investigations. The hassle factor alone has to weigh on WH progress, but the market may be more sensitive to headline risk with each new story.  Democrats spend too much time trying to halt Republican progress and not enough focusing on establishing their own identity.

Legislative Agenda – minimal or zero progress.  No new fiscal stimulus, so lots of stop gap spending measures.

Trade – trade is ruled by Executive Order, so Trump still has full control here.  If there’s a risk, it’s that a frustrated Trump escalates trade disputes and casts Democrats as economic scapegoats.

Fed – Powell & Co may have to assume little fiscal help from their Congressional brethren.  This could translate into slightly less aggressive rate hikes?

Conclusion – not much impact right away, but longer term the biggest risk is that a divided Congress is unable to deliver fiscal or regulatory stimulus to counter an economic slowdown.

Blue Wave aka Be Careful What You Wish For Scenario – Democrats Win Both House and Senate

Who will the Democrats blame in 2020 for two years of slowing economic growth if they win both the House and the Senate?  Oh year, there is that one guy.  But still…this incredibly unlikely scenario could give Trump & Co ammo in 2020.  Markets would be caught off guard, so expect volatility.

Impeachment – odds spike, particularly depending on the outcome of Mueller’s investigation

Legislative Agenda – minimal or zero progress because Trump will retain veto power and block and Democratic bills.  Perhaps an infrastructure bill could gain support from both sides of the aisle

Trade – same as base case scenario, but even greater possibility for escalation

Fed – same as base scenario, may need to take the foot off the brakes and start monitoring the situation

Stocks – negative

Rates – lower, 10T could easily drive below 3.0%

Security – the country will soon be run over by a zombie apocalypse of illegal immigrants

Conclusion – slightly more negative than the base case scenario, but not exactly a meltdown

I Told You The Polls Were Fake Scenario – Republicans Retain Control in Both Congress and Senate

This is only a 12% probability, but FiveThirtyEight has been wrong before. This would be strong validation of the white nationalist policies of the WH.  Of the three scenarios, this would likely have the biggest impact on the market. 

Deregulation – continues aggressively

Legislative Agenda – push to make tax cuts permanent, make another run at Obamacare, formally establish Fox News as state run media

Trade – unchanged

Fed – rate hikes continue as planned with greater possibility of a higher end game

Stocks and Rates – stocks up and rates higher with a steeper curve, with T10 likely breaking 3.25%

GOP – as long as they can enact their agenda, party leaders continue to pretend the guy in the WH is a conservative, didn’t dodge the draft, is morally superior to Bill Clinton (low bar), didn’t collude with Russia, is strong against dictator despots, loves law and order despite breaking the law himself, and didn’t appoint a bunch of cronies deeply embroiled in scandals now or already locked up from the Mueller investigation

Conclusion – this outcome is a mini-version of the 2016 election.  Inflationary, pro-business, deregulation, risk taking animal spirits, etc.  Democrats cry themselves to sleep for another two years.

Election Bottom Line

Democrats will win the House and cry revolution.  Republicans will retain the Senate, possibly even gaining seats.  Market reaction will be muted.  I also think the odds of a deal with China go up once the elections are behind us, which would obviously be received warmly by the markets.

According to left wing think tank Forbes Magazine, here’s how the economy has done since 1947 under various administrations.

Democratic President and Democratic Congress     4.3%

Democratic President and Republican Congress      3.7%

Republican President and Republican Congress       2.7%

Republican President and Democratic Congress      2.5%

Any President and a Divided Congress                        2.4%

As you can see, the most likely outcome of tomorrow’s election traditionally results in the weakest economic growth.  Maybe the best hope for continued economic expansion does in fact come from the great state of Texas…Beto O’Rourke 2020.  I can already see the campaign buttons:  “Beto’s Blue Wave = 4.3% GDP”

“Thank you Texas!” – America

FOMC Meeting – Wednesday

Holy cow, there’s a Fed meeting this week and we haven’t even mentioned it yet!  That’s because this is an off meeting with no Q&A and no updated economic forecasts.  During this tightening cycle, the Fed has not hiked during the alternating off meetings, so the market only has an 8.2% chance of a hike on Thursday.

The market has a 75% probability of a hike in December, however, so there’s potential for market response if the statement deviates from the last meeting.  That’s a low likelihood – Powell doesn’t have much reason to change the signals right now.

This Week

We either descend further into the madness (with Fox and CNN as the biggest beneficiaries) or usher in the first wave of socialism, but at least we have something to talk about.

One last note on Texas – SNL cast member voted “Most Likely to Succeed” Pete Davidson took a pot shot at Navy SEAL veteran-turned-Texas-Congressional candidate Dan Crenshaw’s war injury.  While Davidson was still a teenager, this guy was kicking in doors in Afghanistan when an IED took his right eye.  He deployed two more times after doctors were able to save his left eye.  Davidson had the audacity to mock Crenshaw and then offer a sincere “best wishes” to recently turned ex-fiancé Ariana Grande.  My blood was boiling.

I trained with SEAL teams and I would not generally describe them as a reserved bunch, but to Crenshaw’s credit he took the high road.  “Good rule in life: I try hard not to offend; I try harder not to be offended. That being said, I hope @nbcsnl recognizes that vets don’t deserve to see their wounds used as punchlines for bad jokes.”

And that’s why I love Texas.