What a split Congress means for investors

Gridlock likely, but it's not what the market and economy needs

November 07, 2010|By Eileen Ambrose, The Baltimore Sun

Now that the political pundits have had their say on the impact of the election, it's time to consider what it means for investors and pocketbooks.

The midterm election results and Republican takeover of the U.S. House improve the chances that the wealthy will be included in any extension of the Bush-era tax cuts expiring at year's end. Banks, big oil and high-end retailers likely will benefit, although green technology not so much. And we can say goodbye to stimulus spending to boost the economy and possibly to emergency jobless benefits for the long-term unemployed.

Gridlock is widely expected in Congress, where Democrats still control the Senate. But economists say the country can't afford a stalemate when legislators should be solving the big financial problems — the deficit, economy, Social Security and Medicare.

"We don't have the luxury of waiting another election cycle to see if we can get a unified government," says David Resler, chief economist at Nomura Securities International. "We keep trying to find the right mix [of politicians] to get things done that need to be done. We are running out of time on some of them."

With the new makeup of Congress in mind, here are three things to watch for in the next year or so:

Taxes

One of the most pressing issues is what to do with the expiring Bush tax cuts. That affects almost all of us. President Barack Obama plans to meet with congressional leaders about taxes next week.

There is widespread agreement that the tax cuts should be made permanent for individuals earning up to $200,000 a year and joint filers with income of up to $250,000. But Republicans want tax breaks for higher earners, too.

Democrats might be willing to go along with continuing the tax cuts for the wealthy for a year or two, says Clint Stretch, managing principal of tax policy at Deloitte. They might, for example, offer to extend the cuts temporarily for affluent taxpayers with income of up to $1 million, leaving Republicans to argue for tax relief for millionaires, Stretch says.

Republicans, though, could let the tax cuts expire and try to negotiate a better deal next year when they take control of the House, he says. If that happens, your paycheck will shrink next year because of higher tax withholdings — at least until the tax debate is resolved.

Stock market

If history is any guide, stocks should perform well next year.

Obama will be in the third year of his term, a year that's traditionally strong for stocks. Not since 1939 has the Dow Jones industrial average given up ground the year before a presidential election, and even then it fell only 2.9 percent, according to the Stock Trader's Almanac.

Another positive sign from the almanac (if you're superstitious or a numerologist) — Years ending in "1" are usually positive unless there's a crisis, such as the Depression in 1931, World War II in 1941 and Sept. 11 terrorist attacks in 2001.

But even without a crisis, it might be a rocky ride up.

Stocks will rally at least into the spring in celebration of Republicans capturing the House, but volatility will replace that once gridlock sets in and there's uncertainty about what Congress will do to improve the economy, predicts Laura Gonzalez, an assistant professor of finance and business economics at Fordham University.

The conventional wisdom is that gridlock is good for stocks because no major legislation can get passed to muck things up — playing "squarely into people's cynical view of government," says Robert Johnson, senior managing director of the CFA Institute.

But in reality, stocks — particularly shares of small companies — do better under political harmony where the president and both chambers of Congress belong to the same party, Johnson says.

That would suggest that next year could be poor for small stocks, Johnson says, though Federal Reserve policies could overcome any negatives from political gridlock.

The greater Republican influence could improve the outlook for certain industries.

Traditional energy companies, especially offshore drillers, should see a boost, says Bob Doll, chief equity strategist with BlackRock, an investment firm. Meanwhile, less attention will be paid to climate change, dampening prospects for alternative-energy companies.

Banks and for-profit schools will benefit, too, because Democrats would have pushed harder to regulate them, Doll says. And the forecast for high-end retailers will be brighter if Republicans succeed in extending tax cuts to affluent households.

Republicans won't be able to appeal the health care law, but they could stymie or amend it, experts say.

That could be good or bad for health care companies, says David Straus, senior portfolio manager with Washington-based Johnston Lemon Asset Management Inc. For example, drug companies might not see their profit margins squeezed as much, he says, while hospitals could be hurt if fewer people have to buy insurance.

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