Wednesday, November 08, 2006

Election Effects

Yesterday's mid term election produced a mostly expected result. Market participants anticipated the change of control in the House. Senate control is still up in the air with the Virginia and Montana races still undecided - and recounts widely expected. I think it is likely that both those races will eventually go to the Democratic side as well.

What does this mean for us as investors? As I've stated numerous times, I don't think it makes a lot of difference - at least in the short term. While new Speaker Pelosi has promised greater civility and compromise, I don't expect much to be accomplished in the two years remaining until the next presidential election. Compromise is not in any politician's nature and no matter the words spoken on election night, a Democratic majority in Congress will make little difference in the legislative outcomes.

Prior to the election there were a number of issues that could affect the market and despite a change of control in Congress, the issues remain the same:

1. The expiration of various tax cuts in 2008 and 2010. The current Congress, despite Republican control, was not able to extend the tax cuts. The likelihood of extension is now even more remote. Most important to the markets are the dividend and capital gains cuts which expire in 2010. That was always going to be an issue in the 2008 election and nothing has changed.

2. Minimum wage increase. Minimum wage legislation is likely to pass the House and probably the Senate as well. Bush will likely veto, but there is no guarantee on that since he has yet to veto anything of any importance. I have stated before and still believe the economic impact is minimal. Indexing the minimum wage to inflation would make the legislation worse, but that will probably be resisted.

3. Anti Trade sentiment. There has always been a segment of the Republican party that is anti trade (see Pat Buchanan) and Democrats have been basically anti trade (they call it fair trade, but that is just rhetoric with no basis in economic fact) with the exception of the early Clinton years. This is probably the worst outcome of the election. Free trade (read globalization), by increasing the flow of low cost manufactured goods primarily from Asia, has allowed the Fed to pursue a less aggressive monetary policy by holding down consumer inflation. Were Congress to enact legislation that limits trade, especially from Asia, the result will be higher inflation and likely higher interest rates.

4. Demonizing of corporate scapegoats. The Pharmaceutical and Oil companies should start staffing up the legal departments now. The wind fall profits tax on oil companies - as bad an idea as has ever been tried - is likely back on the table. Hopefully, someone in Congress will be adult enough to point out that this has been tried before and failed miserably. Republicans and Democrats will both be looking to blame someone for their own failures on energy and health care policy. I don't expect any legislation to pass over a veto and therefore this is probably just headline risk.

5. Budget Deficit. I actually don't think the current deficit (or total national debt) is anything to worry about, but politicians sure want to make it an issue. Our national debt, at about 60% of GDP, is among the lowest in the developed world. It's less than Germany, France, Canada, Italy and Japan for example. Would I like to see a lower deficit? Of course I would and I feel certain that any normal person could eliminate the deficit over a long weekend, but don't expect any Congress to seriously address current or future spending. One fear I've expressed here before is that with Democrats in control it will just mean an even worse deficit as they add more domestic spending while the defense spending has to continue (no, I don't expect Democrats to get us out of Iraq).

The bottom line is that little has changed, at least for investors, since yesterday. The change in control of Congress should not change anyone's investment plans and should have little impact on the economy as a whole. Our investment thesis is unchanged.

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