The One Scenario That Could Paralyze Wall Street

Trying to predict how financial markets will respond to news from a political campaign is a mug’s game, especially when the race underway is still stuck at a stage where it’s impossible to tell who is going to end up with the right to challenge President Obama as the Republican Party’s presidential candidate.

Republicans portray themselves as the party devoted to free markets and unrestrained capitalism, and any market-shaking comments in debate forums or political ads will likely be more prevalent in the final race, rather than the Republican primary battle.

Still, Super Tuesday’s results – which, by early Wednesday morning, awarded  six states to Mitt Romney, three to Rick Santorum and one to Newt Gingrich – is possibly the worst possible scenario,  not only for Republicans but also for investors trying to get an edge on what sectors wedge win or lose as the November election looms. Had Romney walked away with a decisive edge over Santorum, some investors who monitor financial markets argue that would have been good news for financial stocks, at least.

Romney is widely viewed as the candidate with the best chance of unseating Obama in November, and also highly unlikely – given his background – to aggressively implement reforms in the Dodd-Frank Act or pursue more regulations that are unpopular on Wall Street. He's not likely to impose higher tax burdens on hedge funds and private capital investment funds, like the one he ran himself that generated a large part of his fortune.

As for Santorum, who has won support by emphasizing his socially conservative views, pundits from the investment world worry that while a win of both the nomination and the presidency would be great news for manufacturing stocks (as a candidate, Santorum has pledged to eliminate corporate income taxes for these companies as a bid to revive manufacturing), the same opinions that appealed so much to a vocal section of the Republican party may not fly with the broader electorate.

Unlike Romney, Santorum can’t point to experience running a business or a state’s finances. Sure, that means he’s immune to charges being levied against Romney that his state healthcare policies prepared the way for Obama’s healthcare reforms, but come the general election in November, that’s not going to matter.

The wildest card of all right now is Ron Paul. He has no incentive to quit the race and every incentive, once either Romney or Santorum is reluctantly accepted as the party’s official candidate, to emerge as a spoiler, and an independent candidate.

If you’re looking for a scenario that really scares Wall Street, that’s it. Some of his more maverick views – dismantling the Federal Reserve; returning to the gold standard – are those they find downright frightening, regardless of their political affiliations. “What happens if this dude comes back as an independent?” frets one hedge fund trader. “What happens if he forces everyone to discuss this as if it’s serious?”

There’s no certainty on the Street that a Republican would be better for financial markets than a Democrat, or even better for stock market sectors, with the possible exceptions of healthcare and financial services. Still, volatility aside, stock markets have fared well in the Obama years: The S&P 500 is up 48 percent  from its December 2008 levels.

Healthcare reform has so far proved less oppressive to companies in the industry than they had feared; in practice, financial industry reforms are being watered down as they are implemented (under pressure from heavy industry lobbying). Even defense stocks aren’t likely to suffer, as long as tension with Iran lingers. So any market moves in the coming months are most likely to come in response to ad hoc comments that one or another of the candidates lets drop, rather than any dramatic policy shifts.

For the time being, it’s not likely that candidates’ policy differences are going to register much for traders. What is being noted, however, is the uncertainty on the Republican front, and what that might mean in terms of future uncertainty. If there is one thing that Wall Streeters hate far more than the most oppressive regulator in the world, it is uncertainty.

This is a particularly bad time for the outlook to be murky: The sanctions against Iran are driving crude oil prices higher;  there’s still little clarity on whether the economy is really moving forward; and there’s no certainty that a Republican victory in November would mark an end to gridlock in Washington.

Some traders, at least, have one very important point in common with Mitt Romney at this point in the race: They wish he was the clear winner, if only so that the debate can shift to the Republican nominee vs. Obama, and they can begin to formulate strategies for what happens after November.