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Investment Implications of the Mid-Term Elections

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PantagesWhile there are a few races too close to call and a couple of run-off elections still to go (Georgia and Louisiana), the Republicans have taken control of the Senate and now have the biggest majority in the House since the 1950s. Divided government is back with President Obama in the White House wielding his veto pen if necessary.

Conventional wisdom says the stock market should do well under a “business friendly” Republican congress. However, the market has had a muted reaction to the election today. Perhaps the rally over the past few weeks was in anticipation of last night’s results? In any event, history suggests that stocks do well regardless of which political party is in control.

The data below from JP Morgan looks at annual stock market returns from 1937 to 2011. As you can see it did best when Republicans were in charge of all three branches of government (RRR) posting an annual return of 17.5%. When a Democrat was in the White House and faced a slit congress (DSPLIT) the return was strong as well at 15.4%. While it is fun to look at these numbers, the history is quite short and we can’t have much confidence in their predictive ability. Besides long term investors should look through these changes in political power and not get caught up in market timing.

Still, here is what we are hearing from Wall Street analysts about the likely effects of the election near term.

Hope springs eternal for some who believe rather than gridlock and bickering, we will see some legislative success as House Speaker Boehner and new Senate Majority Leader McConnell are moderates who want to rebuild their brand. The President will be conscious of his “legacy” and looking for victories. A WSJ article notes that “Much as the President needs to show he can still notch achievements, Republicans need to show voters they are capable of effective governance”.

Morgan Stanley believes that the Republicans won’t go after Obamacare early on as that would “poison the waters” and would doom anything else they want to get done. Holding hearings on “regulatory and executive abuse of power” would do the same.

Some analysts believe immigration reform could get done, but probably not if the President Obama issues executive orders granting new protections for illegal immigrants in the lame duck session coming up. The Presidents post-election press conference this afternoon may provide a hint as to his flexibility on this and other issues.

Senator Murkowski is expected to become head of the Senate Energy Committee and will be a powerful force for energy policy reform for Alaska and other energy states. Approval of the XL Keystone pipeline, that sends 830,000 barrels of oil a day through the middle of the country to Gulf Coast refineries, is more likely. And the ban on crude oil exports may fall by the wayside.

While personal tax reform is unlikely, business tax reform is possible. The US corporate tax rate, at 35%, is one of the highest in the world. A lower rate in return for closing loopholes and more infrastructure spending on roads and bridges might get done. There is support for removing the Obamacare tax on medical devices, which is very unpopular.

Trade legislation will probably get a boost with Republicans giving the President “fast track” authority to do deals with the European Union and Japan and 10 other economies in the Pacific Rim. That’s good for growth.

Some believe the financial sector may benefit. However, Wall Street is out of favor with Main Street. This would seem unlikely to us.

The entitlement reform can is also likely to be kicked down the road again given the sharp improvement in the federal budget deficit.

Historically stock markets have experienced a mild bounce after mid-term elections partly because of the removal of uncertainty. The next big hurdle is the debt ceiling in February where we will no doubt see much horse-trading and brinkmanship. So enjoy this brief respite while it lasts.

My name is Jeff Pantages. I am the CIO of Alaska Permanent Capital Management and I approve this message. (Hopefully that is the last time you will hear a version of that tag line – until 2016!)

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