Brian Jacobsen

Just when you thought it was over: More elections

Economic News and Analysis—11-26-12
Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist


Living in Wisconsin, I was looking forward to going from being in a “swing state” to a “flyover state” at the end of the presidential election. However, I wasn’t banking on much reprieve from politics in the markets. The U.S. faces the fiscal cliff issue, which I think will be dealt with in classic Washington fashion, by punting the problem into next year with the promise of working toward longer-term tax and spending reform. Perhaps even more important for globally oriented investors was the election in Catalonia, Spain, on November 25, an election in Japan on December 16, and Egyptian President Mohamed Morsi’s judicial decree on November 22 that give him expansive new powers until a new constitution is approved.

Catalonia’s elections: No definitive outcome

The election results in Catalonia offer no additional clarity as to the direction the eurozone debt saga will take. The Catalans turned out in large numbers, putting separatist parties in the majority of the regional parliament. The separatist parties are a fractious bunch, differing in their stances on many issues, but they are united in standing for a free and separate Catalonia. Spain’s prime minister, Mariano Rajoy, is part of the Popular Party, which did gain one seat in the elections. Despite this marginal increase in power, the election will make it more difficult for Prime Minister Rajoy to ask international agencies for a provisional line of credit or bailout for its banking sector.

A bailout request by the Spanish government, I think, would be a positive signal for investors. It would help provide support for the eurozone banking system, and it would likely come with terms that would ease funding costs for countries like Greece, Portugal, and Ireland. Easier funding terms would make it more likely that the governments could hit their budget targets. It would also ease the sting of the spending cuts and tax increases being imposed.

The potential market impact: The lack of definitive outcome of the election will likely keep Treasury yields low and European stock valuations cheap.

Japan’s elections: The independence of the Bank of Japan at stake

In 2009, the center-left Democratic Party of Japan (DPJ) unseated the long-ruling center-right Liberal Democratic Party (LDP). On Friday, November 16, the prime minister of Japan, Yoshihiko Noda (member of the DPJ), dissolved the lower house of parliament, setting the stage for a new set of elections on December 16. Shinzo Abe, president of the LDP, has been vocal about pushing the Bank of Japan to weaken the yen to support Japanese exports. This is one reason why the yen has weakened relative to the dollar over the past few weeks.

Stripping a central bank like the Bank of Japan of its independence from political pressures is a dangerous thing. The more independent a central bank is, the less likely it is that its country will experience rapid inflation and low growth. For the past 20 years, Japan has had low inflation and low growth, but high inflation and low growth could be worse. Abe has been talking about an inflation target of around 2%, which is not high. However, once a central bank loses its independence, that 2% could easily be pushed to 4%, 12%, or even higher. There would be the constant threat that the government would address it debts by printing money instead of raising it through taxes. Short-term, higher inflation would likely be good for Japan. Longer-term, the question is whether it would stop at 2% inflation?

The potential market impact: The yen could continue to weaken, which could be good for Japanese exporters.

Egypt: A controversial claim to presidential power

Newly elected Egyptian President Mohamed Morsi took a very controversial step on Thursday, November 22, issuing a decree that gives him immunity and concentrates a lot of power in his office. He claims that this is a temporary measure, to last only until a parliament and constitution can be put in place. The market reaction suggested that investors around the world were skeptical about this claim,  as the Cairo stock market dropped more than 10% on Sunday alone. The real political problem here is that Morsi is a member of the Muslim Brotherhood, which is a supporter of Hamas, which is engaged in violence with Israel. Iran also supports Hamas, so this makes for a twisted and complicated situation.

The potential market impact: Oil prices will likely stay elevated, but could move dramatically, depending on the outlook for the possibility of conflict. Conflict in itself doesn't necessarily push up the price of oil, but it increases the prospect of actual supply disruptions.

The views expressed are as of 11-26-12 and are those of Chief Portfolio Strategist Brian Jacobsen, Ph.D., CFA, CFP®, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.


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