There are several potential candidates for an “October surprise” that might affect the outcome of the US Presidential elections. The surprise the Democrats fear is that Osama Bin Laden is captured, giving President Bush a feelgood factor in the last few days of the campaign. This would undoubtedly give a lift to share prices, although the boost might only be short term.
The surprise all Americans fear is a terrorist attack on the US. This would clearly damage financial markets although how it would affect the election is less certain; some might rally to the President out of patriotism, others might blame him for not protecting the country.
But some believe the potential surprise could be generated from within the markets. After all, October has been a turbulent month in the past, notably in 1929 and 1987. Tim Lee of the Connecticut-based pi Economics has thought for some while that “October could be the time when it all goes wrong for the markets”. In his view, the US’s structural problems, the current account deficit and the low savings rates have now gone to unprecedented extremes.
He says that, for the 20 years up to 2002, there was a tendency for the annual increase in global foreign exchange reserves to fluctuate at a level around 1.4 per cent of US gross domestic product. In the year to the first quarter of 2004, this increase shot up to 7 per cent of US GDP. Lee says that “investors in the dollar are a little like the cartoon character who has run off the end of the cliff and not yet realised that there is no support underneath.”
One problem is that the US current account deficit did not narrow as a result of the bursting of the dotcom bubble. One might have expected the bear market to prompt US consumers to increase their savings, thereby cutting demand for imports. But they did not do so, perhaps because house prices continued to be strong or because they expected the fall in share prices to be temporary.
The irony is that a bull market is dependent on the strong performance of the US economy which in turn depends on a revival in savings. Lee believes that “the inevitable adjustment the US economy has to go through has not even begun.” A crash may be the result.