Friday, October 27, 2006

How the Election Could Move the Markets

News Analysis
October 27, 2006

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How the Election Could Move the Markets

If Democrats take back Congress, it could spell trouble for the likes of Wal-Mart and Big Pharma—and profits for alternative-energy providers

With less than two weeks to go, it's still anybody's guess which party will come out on top in the Nov. 7 midterm elections. Poll numbers for President Bush and the Republicans remain dismal amid ongoing Iraq violence and the aftermath of an ethics scandal involving former Rep. Mark Foley (R-Fla.), but the GOP may still be able to hold onto one or both houses of Congress, analysts say (see BusinessWeek, 10/16/06, "Graphic: The Election at a Glance"). Either way, some investors are probably worrying what the elections could mean for the markets.

In a USA Today/Gallup poll released Oct. 24, 54% of likely voters said they favored the Democratic candidate in their district, while 41% picked the Republican. This 13 percentage-point gap represented a drop from the prior week, but equaled the advantage Republicans enjoyed two weeks before their sweeping 1994 electoral gains. Still, the GOP should benefit from a relatively small number of vulnerable seats and the overall Republican tilt of the most hotly contested districts, according to Goldman Sachs (GS) economist Chuck Berwick.

Whether it's the donkey or the elephant that emerges triumphant, investors shouldn't get too carried away. A shakeup in the Beltway probably wouldn't shake up a well-diversified portfolio, analysts say. "There's no evidence of a statistically significant relationship between political control of Washington and the stock market," notes Mark Riepe, senior vice-president at the Schwab Center for Investment Research (SCHW). Riepe analyzed the total rate of return for the Standard & Poor's 500 index since 1953 and found differences in partisan power had little impact on broader market direction.

New Discussions

The current campaign season isn't anticipated to be much different. "We are hard-pressed to think of a major stock-market-moving event that is likely to come from the midterm elections," Tobias Levkovich, chief U.S. equity strategist at Citigroup (C), wrote in an Oct. 12 note to clients.

Nevertheless, winds of change in Washington might bring new risks—or some advantages—for a few specific stocks and industries (see, 9/21/06, "A Game Plan for D.C. Gridlock"). While a Democratic majority in either chamber would still face the threat of a Presidential veto, any change in leadership might at least change the topics of discussion on the Hill. Companies in the pharmaceuticals and energy sectors might be affected, analysts say, as could Wal-Mart (WMT).

Among the stocks most widely expected to get hurt by Democratic gains are drugmakers, such as Johnson & Johnson (JNJ) or Pfizer (PFE). If Dems take control of even one house, it would raise the odds Congress might amend the Medicare Part D legislation to let the government negotiate drug prices, according to UBS (UBS) strategist Thomas Doerflinger. Democratic lawmakers probably wouldn't succeed in changing the law during Bush's Presidency, but the pharmaceutical sector would still face a "sentiment risk," Doerflinger wrote in an Oct. 18 report.

Energy Surge

Investors could get particularly nervous if Democrats take both the house and the Senate, according to Peter Morici, a professor at the University of Maryland School of Business who served as chief economist at the U.S. International Trade Commission under President Clinton. "Looking down the road, if people see a Democratic Congress, they will start thinking of a Democratic President," Morici says. "And they'll start thinking of the consequences for the health-care industry."

In the energy sector, changes in Congress might leave both winners and losers. On the one hand, a potential push to repeal oil-industry tax breaks or impose gasoline taxes could have negative implications for oil stocks, such as Exxon Mobil (XOM) or Chevron (CVX), UBS's Doerflinger notes. But, he says, Democrats' preference for cleaner fuels could be bullish for General Electric (GE), which manufactures gas turbines, and for alternative-energy plays like Energy Conversion (ENER), MEMC Electronic Materials (WFR), Cypress Semiconductor (CY), or Diversa (DVSA).

Longtime liberal bugaboo Wal-Mart may also come under pressure. The retail giant has recently increased its contributions to Democrats (see BusinessWeek, 10/2/06, "How Business Is Wooing Democrats"). Still, control of the House would probably encourage Democrats to push legislation making it more difficult for Wal-Mart to get a charter that would allow it to process some financial transactions internally, says Andrew Parmentier, managing director of Washington policy analysis at Friedman Billings Ramsey (FBR).

Under the Microscope

Loan providers could also come under the microscope. Current House Minority Leader Nancy Pelosi (D-Calif.) has listed cutting student loan interest rates in half as something a Democratic House would accomplish within its first 100 hours in office. S&P downgraded shares of Sallie Mae (SLM) to hold on Oct. 9, citing the possibility of adverse legislation.


Tougher rules for adjustable-rate mortgages might also be in the cards in a Democratic Congress. S&P recently downgraded several regional banks that do mortgage-origination business, including FirstMerit (FMER), Commerce Bancorp (), and Wilmington Trust (WL). On the plus side, S&P sees good news for Fannie Mae (FNM) and Freddie Mac (FRM) if new laws push borrowers toward fixed-rate loans.

A variety of other industries could face scrutiny. If the Dems put forth legislation on "Net neutrality," it could hurt telecom companies like AT&T (T), according to Doerflinger. However, he predicts that defense industry would remain strong, even though Halliburton (HAL) could face the risk of Congressional hearings investigating the process by which a subsidiary was awarded contracts for reconstruction and development work in Iraq. "If defense stocks trade down on a Democratic win, we believe it could create a buying opportunity," Doerflinger says.

Whatever happens Nov. 7, analysts say, investors looking to trade on the results shouldn't change their long-term allocations, and they probably shouldn't wait until Election Day. Politics may be tough to predict—remember "Dewey Defeats Truman"—but that doesn't mean Wall Street isn't already trying.

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