You knew it had to happen. As we get more and more signs that Hillary Clinton is pulling away from Donald Trump in the polls, we are hearing rumblings that not one but both houses of Congress could go to the Democrats. I am starting to think that's a major reason why stocks aren't acting well in the face of what's turning into a pretty decent earnings season.
Maybe the debate tonight reverses the course of things, but I think it's important to, for the first time in ages, put stocks in the context of a potential landslide, and what that would mean.
First, it would elevate the more radical base of the Democratic Party, think Bernie Sanders and Elizabeth Warren, and you know what I mean.
The government intervenes in so many different ways in the private sector, but the most visible ones, at least to me, are banking, health care and environment, where rules are made that can make or break earnings per share.
Let's start with banking. Until the landslide talk, the rap on Clinton was that she would be more reasonable toward the banks than President Obama because she's been a big beneficiary of their giving and because she's spoken to many financial interests, not the least of which is Goldman Sachs (GS) . Anyone willing to sit down and talk with bankers about their issues means the banks might be more insulated than they have been under Obama.
But if Congress goes Democratic? I think you would see an environment in which banks might be right back into the crosshairs of Congress. What that would mean is more regulation, and that means more people who don't generate revenue will have to be hired to monitor and make sure these regulations are followed. You would see that there would be multiple discussions about whether the big banks are too big and too powerful. You could even see suggestions that larger returns from banks might mean they are taking too much risk and need to be clamped down on again.
Why do I say all of these topics are in the air? Because take a look at how the stocks of the banks have done in what can only be described as the best quarters in years, quarters where divisions that have been drags, like fixed income, turned into roaring profit centers, and where commercial and consumer lending have become unmitigated bright spots.
But right now there is a seething debate in the Democratic Party about concentration in banking. We used to separate actual banking from investment banking, meaning that we had banks that did lending and banks that were allowed to do the larger portions of corporate finance that can and have been so profitable to these enterprises. The Glass-Steagall Act, as it was known, didn't want depositors' money to be mingled and put at risk by these non-traditional lending portions of the business.
But 17 years ago it was repealed, and banks could mingle these two different kinds of businesses under one roof. Now in the aftermath of the destruction of value that the banks were very much involved in because of risky practices, Congress passed the Volcker rule, which eliminated a lot of risky practices.
But if Glass-Steagall were to come back to life, you would see companies like Bank of America (BAC) , JPMorgan (JPM) and Citigroup (C) torn asunder. They would be dismantled. You have to ask yourself, is that why these companies have had such muted reaction to tremendous numbers?
You also have to ask yourself whether the whole notion of banks being too big to run efficiently or honestly would come back to life. We may think the cross-selling scandals of Wells Fargo (WFC) are one-off. But believe me, a populist Congress could pass rules that block cross-selling or severely limit it altogether. That's the price the industry might have to pay for the injustices Wells committed.
Or maybe the president and Congress revert to the ways of the Founding Fathers, who didn't want banks to be so powerful and limited any one of them to having no more than 10% of the country's business. Because of the exigencies of the Great Recession, we saw Bank of America, Wells Fargo and JPMorgan put together powerhouses that far exceed those percentages, even as many of the deals were done on behest of the government. They could just as easily be undone. That would crater the group. And let's be sure, I bet a really aggressive Congress could put fee limits and even interest-rate caps on a whole host of products.
In short, it could be a nightmare for the group. I think the stocks are saying don't rule out that nightmare.
How about the drug stocks? Yesterday, Johnson & Johnson (JNJ) reported what I thought was a tremendous quarter. But during the Q&A, California's Proposition 61 came up, which is an appeal on the ballot in California that would allow the state, which spends billions on drugs a year, to demand Veterans' Administration prices for drugs it buys. The VA gets a special break because it provides health care to servicepeople. Given how incredible it is that people serve in harm's way to protect that makes sense. But if this proposition passes, and it was thought to be pretty much doomed for defeat a couple of months ago, you are going to see a groundswell by states and even the feds to limit how much they will pay for drugs. That could crush profitability for these companies.
Plus, we know that pharma is Public Enemy No. 1, whether it be the outrageous price increases that some miscreants have put through or the tussle over the EpiPen, or the desire of the federal government to crack down on even orphan drug pricing. An energized Congress teamed with a left-leaning president and armed with a victory in Proposition 61 would just annihilate this group. That's the reason, I believe, why biotechs act so badly in addition to the funky way the street viewed JNJ's results. This group, which is so sensitive to random tweets by Sanders or Clinton, has become persona non grata ahead of the election and I don't think that will change until we see how much of Congress goes Democratic.
Then there are the rules for the environment. We have had a bit of a coal comeback of late, but you can forget that if the Democrats sweep. You can even begin the countdown to the end of fossil fuels in the country, starting with the so-called bridge fuel of natural gas. The oil stocks have been rallying on the move past $50 for crude after we have seen tighter inventories, but this is a group we will most certainly pay less for if Congress changes hands.
Oh, and forget about mergers. I would expect an antitrust department that would try to block anything that would create any concentration, whether it be the Bayer-Monsanto (MON) deal or Dow (DOW) and DuPont (DD) or even Walgreens (WBA) and Rite Aid (RAD) . Just ain't gonna happen. (Citigroup, Dow, Wells Fargo and Walgreens are part of TheStreet's Action Alerts PLUS portfolio.)
Now, I do hear that there could be some positives for business. For example, we get lots of chatter that there will finally, at last, be more spending on infrastructure, which would be a boon to Caterpillar (CAT) as well as the aggregate makers, Martin Marietta Materials (MLM) and Vulcan (VMC) . But all I can say is, really? You think that can make up for all these issues?
So, no, don't be fooled into thinking the tepid action in the winners so far in the earnings season indicates that the results are subpar. Instead, focus on the fact that Clinton's strength might mean money managers are exiting anything that the government can reach into and squelch. If that's the case, then this market will have a bias down despite those excellent numbers as government interference is a sure killer of any expansion of valuation for stocks, even if the current earnings vastly exceed expectations.