Wall Street Not So Afraid of Outcome

Wall Street in recent weeks has become much less confident about President Bush’s reelection chances, as many polls have indicated an ever-tighter race with Sen. John F. Kerry.

On Friday, election futures contracts traded on Intrade.com -- an electronic market that allows investors to bet real money on politics, the weather and other current events -- showed Bush with a 51.1% likelihood of winning. That was down from 68% in late September.

The Dow Jones industrial average had mostly been trending along with the conventional wisdom that Bush is the choice of big investors: As his chances appeared to be dimming, the Dow fell to an 11-month low by Monday.

But if Wall Street is overwhelmingly afraid of Kerry, the market’s direction after Monday was puzzling.

Blue-chip stocks had their strongest two-day rally in 18 months, pulling the Dow back above the 10,000 mark to 10,027.47 by Friday.

And the technology-dominated Nasdaq composite index shot up 3.1% for the week, building on a rally that has left the Dow in the dust. Since Labor Day, the Nasdaq index is up 7%, while the Dow has declined 2.3%.

If financial markets are supposed to have predictive powers, what are they saying about the election?

Every survey of professional money managers shows that they favor Bush over Kerry. That has raised concerns about what might happen to the markets if Kerry was to win Tuesday.

Many analysts have suggested that healthcare, defense, tobacco and energy stocks could take a sharp hit if Kerry was elected, because he is considered to be unfriendly to those industries in various ways.

But last week demonstrated that investors have a lot more on their minds than just who takes the White House.

One catalyst for the stock market’s gains last week was a sharp pullback in oil prices, after they reached a record $55.17 a barrel Tuesday. By week’s end, the price was at $51.76.

If Kerry was to win and oil to continue sliding, which would matter more to Bush’s disappointed Wall Street supporters in the short-term?

There is no question that the financial elite prefer Bush, at least for their stock portfolios. His tax-cutting agenda is viewed as far more likely to result in economic growth, which is what the stock market wants.

In a Barron’s magazine poll of about 90 institutional investors early this month, 85% expected Bush’s reelection.

Still, these aren’t people who are likely to liquidate their portfolios if Kerry is elected. For one thing, they know what history says about the stock market’s performance under Democratic versus Republican presidents.

Since World War II, the Standard & Poor’s 500 stock index has posted an average total return of 14.2% a year when Democrats have been in the White House, according to a study by Wayne Hummer Asset Management Co. in Chicago.

The average annual gain has been 10% under Republicans.

Long-term bonds, by contrast, have generated bigger total returns under Republicans than under Democrats. That suggests that interest rates have been more likely to decline under Republicans, because falling rates boost the value of older bonds.

How much the presidents themselves actually have had to do with those returns is unmeasurable. When a financial market is ready to rally -- for whatever reasons -- the political climate may matter little. And the same can be said when a market is ready to go down.

Even so, the numbers may dispel the notion some investors still have about Republican administrations always being better for stocks.

Kerry has made enemies on Wall Street by promising to raise taxes on the highest-income earners. Yet President Clinton raised tax rates, and then presided over a major economic boom and a rocketing stock market. Big-money investors haven’t forgotten that era. It made them massive fortunes.

History aside, there is another big reason why many investors would be unlikely to sour on stocks in the near term because of a Kerry victory: As president, the Democrat would face virtual gridlock in terms of major policy initiatives, assuming the Republicans retain control of Congress.

“There are only two possible outcomes for this election,” said David Kelly, economist at Putnam Investments in Boston. “Either George Bush gets to run the Republican government of the United States, or John Kerry gets to run the Republican government of the United States.”

Generally disdainful of government, Wall Street has never complained about gridlock -- at least when Democrats have been in the White House.

The risk of gridlock now, however, is that the nation is facing some pressing problems that will only get much worse if they aren’t dealt with soon. Everyone knows, for example, that Social Security and Medicare need serious reforms ahead of the baby boomer retirement wave, or the money may run out.

Some would argue that the money is already gone, given the prospects for continuing annual budget and trade deficits in the hundreds of billions of dollars.

But the deficits aren’t on the public’s list of key concerns at the moment, and neither are they on Wall Street’s list. Neither candidate is likely to be elected for his plan (or lack thereof) to deal with the deficits.

The stock market is always looking ahead, but it’s mostly concerned with the next six to 12 months. So whether a sustainable rally will ensue after the election will depend more on forces that are already at work in the economy.

The Federal Reserve looms large, as always. Many analysts believe the Fed will pause soon in its campaign to raise short-term interest rates. That could be bullish for stocks regardless of who wins the election.

Some market veterans who have an optimistic economic outlook expect the stock market to get a lift after the election no matter who wins.

Leo Grohowski, chief investment officer at Deutsche Bank in New York, thinks the market has been held back by high oil prices and by uncertainty over the presidential race.

If Bush wins, Grohowski expects a quick 3% to 5% rally in major market indexes. If Kerry wins, the market will be up the same amount by year’s end, but it won’t be immediate, he said.

Decent economic growth, still-rising corporate earnings and subdued interest rates are making for “a reasonably equity-friendly backdrop,” he said -- and one that isn’t likely to change much, in the near term, just because of the election.

*

Tom Petruno can be reached at tom.petruno@latimes.com.