Friday, November 10, 2006

Stocks: Sizing Up the D.C. Shakeup

News Analysis
November 10, 2006

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Stocks: Sizing Up the D.C. Shakeup

Which big names look set to gain—or lose—with the Democrats taking Congress? Here's a rundown

It didn't take long for the stock market to shake off its post-election hangover. Index futures pointed lower ahead of the bell on Nov. 8, a day after Democrats seized control of the House of Representatives and—at that point possibly—the Senate, but stocks wound up finishing higher on the day (see, 11/9/06, "Stocks Rise as Dems Gain, Rumsfeld Resigns").

The Dow Jones industrial average touched a new all-time closing high. The blue-chip benchmark did slip in afternoon trading on Nov. 9, as investors appeared to take some money off the table after the market's recent winning streak.

Despite big changes in Washington, the major factors affecting Wall Street may stay the same. Stocks typically gain the day after midterm elections, no matter which party emerges the victor, some analysts say.

Meanwhile, the longer-term factors driving the market—oil prices, interest rates, housing, and corporate profits—are expected to remain unaffected by the current power shift. The threat of a presidential veto and Democrats' hopes for 2008 will likely keep sweeping new legislation to a minimum, analysts say.

Still, gridlock isn't necessarily as good as conventional wisdom may dictate. "Gridlock is the last thing America needs," says Stephen Roach, chief economist at Morgan Stanley (MS), in a Nov. 9 report. "Granted, there are times when government can indeed get in the way. But there are also circumstances which demand leadership and decisive policy actions. This is one of those times."

Meanwhile, the Democratic wave in Congress has already affected sentiment for several specific stocks and sectors (see, 10/27/06, "How the Election Could Move the Markets"). This special edition of Five for the Money looks at key segments of the market that could draw extra attention as a result of the recent elections.

1. Health Care
The Democrats' gains have been strong medicine for Big Pharma shareholders. The NYSE Healthcare index fell 1.6% on Nov. 8, and was off another 2.1% in afternoon trading a day later. Dow components Johnson & Johnson (JNJ) and Pfizer (PFE) were among the decliners. Managed-care stocks also took a hit amid UnitedHealth Group's (UNH) stock-options woes (see, 11/9/06, "UnitedHealth's Options Just Got Messier").

Investors may be worried about possible importation of drugs from Canada and new legislation that would allow the government to negotiate Medicare Part D prescription-drug pricing directly with pharmaceutical companies, analysts say. "While we think some concession may be made on importation, we think gridlock will continue on Medicare pricing, given opposition from Senate Republicans and President Bush," says Standard & Poor's analyst Herman Saftlas.

2. Energy
The shifting electoral winds were a little kinder to Big Oil shareholders, but analysts see some potential pitfalls ahead. The NYSE Energy index added 1.6% on Nov. 8, and was up another 1.2% in afternoon trading the following day. Oil giants Exxon Mobil (XOM) and Chevron (CVX) shared in the gains, as crude oil futures rebounded above $60.

However, possible Democratic legislation could hold negative implications for oil, coal, and gas stocks, analysts say. "The sector does face some headline risks in the form of Democratic proposals like a windfall profit tax," says Jeff Kleintop, chief investment strategist for PNC Wealth Management (PNC). "You've also got some issues around clean air and climate-change regulation favored by the Democrats that could push up costs for some energy companies."

On the other hand, certain energy stocks might stand to benefit under a Democratic administration. The PowerShares WinderHill Clean Energy (PBW) exchange-traded fund gained 1.4% on Nov. 9, holding near the unchanged mark in afternoon trading the next day. "The market's initial reaction to the sweep by the Democrats has favored alternative-fuel companies, on the back of the belief that they are going to help sponsor government-run programs that would help wean America from overseas oil," says Quincy Krosby, chief investment strategist at The Hartford (HIG).

3. Fannie, Freddie, and Sallie
The Democratic takeover in Congress may also give a boost to certain government-sponsored enterprises, or GSEs. Fannie Mae (FNM) surged 7.9% on Nov. 8 (see, 11/8/06, "Fannie Mae Gains Some Breathing Room"), while Freddie Mac (FRE) added 2%, though both stocks were lower in afternoon trading the next day.

Democrats favor more lenient regulation of the GSEs, analysts say, though probable House Financial Services Committee Chairman Barney Frank (D-Mass.) has said he would push to reform the two companies.

However, shares of the parent company of Sallie Mae (SLM), a former GSE, dropped on Nov. 8 and again in afternoon trading Nov. 9. A top legislative priority of likely House Speaker Nancy Pelosi (D-Calif.) is cutting interest rates on student loans. Some analysts say that could hamper SLM, as Sallie Mae is now known.

4. Retailers and Restaurants.
Liberal bogeyman Wal-Mart (WMT) could also face challenges under a Democratic Congress. Shares of the retail giant fell 1.3% on Nov. 8, and were slightly lower in afternoon trading the next day. PNC's Kleintop says the electoral results are "negative at the margins" for Wal-Mart because of the possibility of stepped-up efforts to unionize the company's stores.

While Wal-Mart pays even its least-compensated employees more than the federal minimum wage of $5.15, companies that do pay the minimum might see their costs rise. Six states passed minimum-wage ballot measures in the Nov. 7 elections, and Pelosi has said a minimum-wage hike would reach the House floor within the first 24 hours after the new Congress meets in January. On Nov. 8, President Bush suggested he would be willing to work with Democrats on boosting the federal minimum wage, which has not been changed since September, 1997.

"Companies that have benefited from low-cost labor are probably going to see some wage pressures," says Barbara Walchli, who manages the Aquila Rocky Mountain Equity Fund (ROCAX). Investors should watch out for restaurant stocks and stocks of retailers that rely on low-wage workers, Walchli says.

5. Defense
Defense companies also suffered stock weakness in the trading session after the elections. Shares of both Lockheed Martin (LMT) and Northrop Grumman (NOC) fell on Nov. 8, though Northrop was modestly higher in afternoon trading Nov. 9. Meanwhile, shares of Boeing (BA) were up both Nov. 8 and 9.

Notwithstanding the prominence of Democratic opposition to the war in Iraq, the election results probably wouldn't put additional pressure on the defense sector during the next two years, some analysts say. "Defense spending is unlikely to decline, despite earlier concerns that Democrats might shift funds from defense to domestic programs," says Goldman Sachs (GS) economist Alec Phillips in a Nov. 8 report. "With an eye toward 2008, Democrats are apt to spend just as much as Republicans would have on defense, though the funds might be distributed slightly differently within the defense budget."

The defense sector may turn out to be a metaphor for the broader market. Democratic leadership in Congress may affect how gains are distributed across individual stocks and sectors, but broader market direction will be determined by fundamentals, analysts say.

"The markets overall will focus on the things that they always focus on," adds the Hartford's Krosby. While Wall Street gets used to new faces in Washington, a cooling housing market and some projections for slowing corporate profits could still give traders plenty to worry about before the next elections.

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