After months of campaigning in the US midterm elections, the Democrats retook control of the House of Representatives and the Senate for the first time since 1994.
The critical question that investors are asking themselves is, how much will this election affect the markets? In our view, the answer is probably not as much as many observers think.
Overall, the election results have not affected our broad outlook for the equity markets. We have been saying for some time that there are some risks to the markets in the form of potential earnings’ disappointments as a result of a likely slowdown in the economy but over the long term, the outlook for equities remains bright.
The history of market performance following a change in Congress during a mid-term election suggests that stocks may be in for a good 2007. Over the past 100 years, when there has been a change in control in either or both houses of Congress, the performance of the market from election day to year-end has been relatively flat. The following year, however, stocks have exhibited above-average performance.
Also, the second year of presidential terms (such as 2006) are often accompanied by a significant low point in the equity markets. From that point, stocks have tended to rally significantly in the last two years of presidential terms. In fact, since 1900, there have been only two occasions when this did not occur once during Teddy Roosevelt’s second term and once during the Great Depression.
Regarding tax policy, the Democrats will almost certainly try to push for a reduction or repeal of the 15 per cent capital gains and dividends tax policy or might be reluctant to extend it through 2010. This would be broadly negative for stocks but would be likely to benefit municipal bonds as their tax advantages would become more valuable. President Bush has, however, promised to veto any such legislation.
The energy sector may be subject to further regulation by Democratic initiatives. This may affect energy stocks negatively in general, but “green-friendly” legislation could benefit alternative energy companies. If high oil prices again become a hot political topic, the Democrats could renew calls for windfall profit taxes, which would be negative overall for the industry.
Trade has been a hotly debated political issue, with many Democrats making noise about engaging in more protectionist trade policies. We believe this would benefit some manufacturing sectors of the market but may act as a drag on economic growth and overall market performance.
Minimum wage increases are generally supported by the Democrats. Although this is a popular move with workers, it would hurt labourintensive industries such as restaurants. Such legislation would primarily benefit less wealthy Americans, which could in turn help mass-market retailers. Due to popular support, its passage is quite likely.
On the domestic front, healthcare is likely to see the biggest overhaul. In our opinion, companies running hospitals or nursing homes might benefit as Democratic plans for spending cuts tend to be more favourable toward these industries.
Additionally, the Democrats will almost certainly push for legislation that would change the Medicare Drug Benefit plan to allow for direct government price negotiation with pharmaceutical companies, which would likely be on overall negative for the industry. Such a move, however, may benefit companies that focus on generic drugs.
The Democrats are also likely to push for a reduction or an elimination of the Medicare managed care stabilisation fund, which we believe could create headline risk for managed care companies.
Bob Doll is vice-chairman and chief investment officer of equities at BlackRock MLIM