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Does Cantor's Defeat Signal More Dysfunction to Come? There's an Asset Class for That


House Majority Leader Eric Cantor was voted out of office on Tuesday, leading many to believe more political crises are on the horizon.

The market's reaction to the shocking defeat of Eric Cantor, the No. 2 Republican in the House of Representatives, during Tuesday's primary election, showed that financial markets still worry about gridlock in Washington. Cantor had served as House Majority Leader since 2011, navigating the GOP through various budget standoffs, and looked to be developing an ability to negotiate with rival democrats. With the selection of David Brat, an activist in the Tea Party movement, however, investors question whether political strife is again on the horizon.

A recurring word that continues to describe not just the GOP, but the entire political system in the US is "dysfunction." Dysfunction is not a term investors like to hear, especially when it refers to a supposedly risk-free entity that is the US government. In December 2013, it looked like some of that dysfunction was subsiding. Both Democrats and Republicans agreed on a budget deal that contained small accomplishments for each party. The major takeaway was the promised end of last-minute, crisis-driven budget battles that roiled financial markets in the past. With Brat now entering office, fear of those crisis-driven battles has reemerged.

On Wednesday, the day after Cantor conceded defeat, SPDR S&P 500 Trust (NYSEARCA:SPY) fell sharply in morning trade. In the chart shown below, the mere hint of further political disruptions to financial markets led to a small sell-off at the open. On a broader time frame, a complete shutdown of partisan cooperation could incite a sell-off that takes the market much lower, off of record highs.

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An example of how financial markets could handle further political disruptions is seen in the chart below. During the summer of 2011, lack of congressional order over handling the debt ceiling ended up knocking the S&P 500 (INDEXSP:.INX) off of its 52-week highs. The markets broadly sold off after the US government's credit was downgraded, and consolidated around its lows for a few months before resuming the trend higher.

In 2013, however, the government shutdown in the fall led to volatility and selling, but did not derail the overall trend. The 2013 bickering was not nearly as impactful on US markets considering it was the second go-around in only a few years, and markets knew each side would hold out until the last second. With new leadership in office, the GOP could be willing to go over the fiscal cliff in an attempt to prove a point. One of the reasons Cantor lost was because he was deemed too "middle of the road." If Cantor is too "middle of the road," then how radical are GOP voters willing to get?

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In the event further instability arises due to political wrangling, iShares Barclays 20+ Year Treasury Bond (NYSEARCA:TLT) remains a wise investment. In the past, the long-dated Treasury bond has shown solid demand during political crisis, even when its backers were creating the geopolitical event. The 2011 spike was more pronounced than the one in 2013, but, as was stated earlier, there was far more fear during the 2011 debt ceiling negotiations. Although some investors may be hesitant to move their funds into an asset actively being sold by the Federal Reserve, it has been shown in the past that the "fear" trade always wins out.

Earlier in the year when the Fed began its stimulus removal process, tension between Russia and Ukraine led to a rush of funds into US Treasuries. With Cantor out of office, the political landscape becomes that much more interesting and uncertain in Washington. Although there may be fear over what will happen next, there is always an asset class to hedge your portfolio during times of crisis. If history stands to repeat itself, that asset may just be US Treasuries again.

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Andrew Sachais' focus is on analyzing markets with global macro-based strategies. He takes into consideration global equity, commodity, currency, and debt markets. Sachais is a graduate of Georgetown University, where he earned a degree in Economics.

Follow Andrew on Twitter: @MacroInsights
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