The economy was not a major factor in the last couple of elections, but that very well may change in 2008. Today's Washington Post asks "Where is the Economy Headed?"

The U.S. economy can't seem to make up its mind.

It keeps showing strength and weakness, with fresh data yesterday providing still more mixed signals -- and fueling a debate over whether the housing slump is dragging the nation into a recession.

The conflicting data could be a sign that the economy is turning, with what was at first a mild growth slowdown about to give way to a harsher downturn, some analysts said. But others echoed the Federal Reserve, countering that the worst news is still coming from businesses involved in housing and automobile production while the rest of the economy is holding up.

In the 2004 campaign the stock market and the general economy turned around sharply in the spring/summer of 2003 well ahead of the fall 2004 election. Also, not unimportantly, housing prices remained very strong throughout 2003 and 2004. In 2006 with four years of solid 3%+ GDP growth, the DOW at all time highs and unemployment between 4.4 and 4.8% all year it was hard to make the "bad economy" a real salient issue, though high gas prices through the first half of the year did substantially reduce the Republicans ability to exploit the good economy to their advantage. The turndown in housing prices came too close to the election to have a substantive impact one way or the other.

This could be very different for the 2008 cycle. It is not what the economy is doing the three months before election day, but rather the 18 months before an election and more importantly the trend of the economy in the 18 months before election day (March 2007 - October 2008) that really matters. In today's political world, it is not just the unemployment rate or GDP that is important to monitor but also housing and equity prices. The new investor class and voter has a tremendous proportion of their wealth tied into housing and the stock market and these gauges are as important and probably more important to the '08 election than the unemployment rate. Certainly if we are talking about fluctuations in the unemployment rate between 4.5% and 6.5% which has been the range the last ten years.

A sustained recession in housing that led to a general recession starting in 2007 that carried over into 2008 would become a major campaign issue both in the primaries and general election campaigns. If this were to play out the Republicans may be very happy to have turned the Congress over to the Democrats this cycle taking away the ability for Democrats to blame Republican government and also providing the opportunity for the GOP to run against the Democratic Congress.

The Post article punts on taking a position as to which way the economy is heading quoting analysts on each side of the debate. Interestingly Forbes' publisher Rich Karlgaard reported yesterday that Ken Fisher who runs the $35 billion Fisher Investments is extremely optimistic heading into 2007:

Ken Fisher spoke Sunday and today. Ken, of course, is the longtime Forbes columnist (22 years) who by day runs Fisher Investments. Some of his thoughts:

-- Markets are discounters of all known information.

-- The S&P earnings yield is 6.8%. The 10-year U.S. Treasury bond is 4.45%. The gap will close. It always closes over time. If the gap closed simply by lowering the S&P earnings yield to match the 10-year U.S. Treasury bond, the market would go up 47%.

-- Third-year presidential terms are usually big-growth years for the market. We haven't had a negative third-year presidency since 1939.

-- Around the world, companies are buying back their stock. We are globally destroying the supply of equities at a rate of 5% a year. This is mind-boggling.

-- I am wildly optimistic about 2007.

I don't have a firm opinion on what the market or economy may do the next two years, though I do think the inverted yield curve is certainly a reason for caution, as well as the increased instability in the geopolitical landscape. Politically, if we were to see a substantial fall in housing along with a general recession, the new minority status for Republicans in Congress will work well for the GOP in 2008. The Democrats will be in much stronger shape if Ken Fisher's scenario materializes.