My Analysis of the Election

Won the World Series, but lost the Speaker of the House. I guess San Francisco can’t have everything. My expectation that demographic trends would limit Democratic losses turned out to be wrong. The kids stayed home and texted each other, partied, or watched MTV, and didn’t go to the polls. I thought that if the Republicans won the House of Representatives, it would be by handful.

They ended up taking 62 seats. Good thing my market calls are better than this, or I’d be washing windshields for a living at Park Avenue and 42nd Street. I nailed the Senate, which I correctly predicted the Tea Party would blow for the Republicans. I even called the spoiler states, Delaware and Nevada.

The West coast turned out to be a clean sweep for the Democrats, as I expected. Meg Whitman spent $35 per vote, versus 60 cents for Jerry Brown, and still lost by 13 percentage points. She probably would have done better if she just sent everyone a check. The sleeper that no one is paying attention to here is that simple majority rule for the legislature passed, dumping the 2/3 requirement. California taxes are about to go up a lot.

Still, without the presidency and the Senate, all conservatives have really won is the right to determine the House agenda, make speeches, and conduct investigations, which I am sure there will be a lot of. One newly elected conservative has even promised to hold McCarthy style un-American activities hearings. You can forget cooperation with the administration. These are not your father’s Republicans. They have been rewarded for obstruction, the Senate setting an all time record for filibusters, so you can expect it to continue, or intensify. Bring on gridlock.

Let’s put the economic polices the voters chose under the microscope and see what we got. It is not a pretty picture. The bottom line is that my scenario of a lethargic 2-2.5% GDP growth rate continues for the foreseeable future. Here are the reasons why:

1) The party with the worst job creation record in a century is now in charge of job creation. There were 23 million jobs created from 1992-2000. There were only 1 million created during 2000-2008 when the population grew by 22 million.

2) The party that presided over the biggest increase in the deficit in history, from $5 trillion to $10 trillion during 2000-2008, is now charged with reducing the deficit.

3) Republican deregulation policies favor large multinationals that have been the most profitable, because they have been the most aggressive exporters of jobs. Small businesses that generate the most jobs don’t show up anywhere in this picture.

4) Without any further assistance from Washington, the states and municipalities are going to have to take an extra sharp hatchet to budgets for teachers, police and firemen, the most junior claims on local resources. The drag on the healthy parts of the economy increases.

5) Much of the campaign focused on cutting the deficit by reducing spending. Below, please find the six largest expenditures in the $3.5 trillion 2010 Federal budget:

$687 billion - Social Security
$655 billion – Defense
$564 billion – Unemployment and Welfare Payments
$448 billion – Medicare
$287 billion – Medicaid
$162 billion – Debt service

Notice, first of all, that you did not see these numbers anywhere during the campaign. They should have been posted at every ballot box along with a Sharpie marking pen. Looking at the list, I see three untouchable Republican sacred cows, social security, defense, and Medicare, taking up the bulk of the spending. Debt service is untouchable. That leaves unemployment and welfare payments and Medicaid as big fat targets.

But even if you completely end this spending, close the agencies involved, and sell off the buildings, as many conservatives have proposed, you have only cut spending by $851 billion, or 61% of the current budget deficit. Some $549 billion of deficit remains. And this assumes the tax rates remain the same. Cut taxes, and the Medicare, unemployment, welfare-free budget deficit rockets to $1.2 trillion, while at the same time slowing GDP growth substantially further. Did I mention that falling spending causes job losses? Talk about jumping out of the frying pan and into the fire.

The mostly closely guarded secret of this election is what spending the Republicans cut in their first budget. I am waiting with baited breath to see how they do this.

Who really won this election? I did! It is setting up trends in the global financial markets that will be easy to identify and cash in on. If you want to jump on my bandwagon and get a peak at some market timing, then keep reading this letter.

While voters may be enthralled with empty promises, platitudes, spin, and sound bites, markets clearly aren’t. Like a huge, dumb animal, they respect only the remorseless mathematics of supply and demand. QEII is still the principal driver, the first $600 million of which we got today. This promises to lift all boats, especially the yachts, to year end, and possible through Q1, 2011 (click here for “Contemplations on Risk” at ). When it ends, the full impact of this election will bite. This will be the outcome:

1) There will be a major sell off next year, not just in stocks, but in all asset classes. The election results increase the certainty and the severity of this event. Volatility (VIX) will rise across the board.

2) The deficit will rise faster. The debt markets’ breaking point will be reached sooner. This means we will get a collapse in bond prices, no matter how much liquidity floods the system. Whether this happens with the national debt at $15 trillion, $18 trillion, or $20 trillion is anyone’s guess. We are headed towards all of those numbers trapped in a runaway Toyota with the accelerator stuck on the floor.

With the administration and congress gridlocked, the Federal Reserve is the sole functioning branch of government, and creating inflation is virtually the only thing they know how to do well. This nicely sets up my (TBT) trade, one of my core shorts for the coming decade.

3) A flight to safety will trigger an extended period of dollar strength. This is bad for stocks, commodities, emerging markets. Flip the “RISK OFF” button. This sets up the crash in the yen, my other core short of the decade, and bodes well for the (YCS).

4) Since many conservatives believe that global warming is a leftist hoax, you can expect more favorable policies and tax treatment for oil, natural gas, and coal. Expect dependence on foreign energy sources to rise and crude prices to rocket. The congressman who apologized to BP for it harsh treatment is now the chairman of the House energy committee. The Bush administration took oil from $20/barrel to $150. Expect something similar going forward. The giant target on our backs in the Middle East stays there. Buy your electric car now.

Sorry, guys, but read it and weep. As with a World Series umpire, I call them as I see them. This is the letter where hard data and facts trump uninformed opinion every day of the week. There are thousands of letters out there whose primary goal is to make you feel better. This isn’t one of them.

To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.