Pre-election, hope blossoms again on Wall Street

Predicting the U.S. stock market’s direction over the next two months may be a simple exercise: Just watch how Republican candidates for the House and Senate are faring in the polls.

At least, much of Wall Street is hoping it’s that easy.

Every midterm election is about challenging the decisions of the party in power. But the Republican message in 2010 is that the economy can’t get better — and will only get worse — unless the Obama administration is stopped in its tracks by a resurgent GOP.

So if investors who buy into that view sense a big Republican victory, they should find a lot more to like about the stock market. That’s the bullish case of the anti-Obama camp, anyway.

Meanwhile, the threat of a Republican sweep may be driving the administration to push for new business-focused tax breaks aimed at spurring jobs and keeping the economy from falling back into recession.

For many equity investors that may be a minor comfort, but it’s still more likely to boost optimism than feed pessimism in the short term.

This week, the economy showed signs of resilience that threaten to blunt the GOP’s thrust against the Democrats. A report Wednesday on August manufacturing activity was stronger than expected. So were many retailers’ sales reports for the month.

And on Friday the monthly employment report showed the economy still lost jobs in August, but about half as many as expected.

The stock market, beaten down last month by mounting fears of a new economic slump, staged a strong rebound to open September. The Dow Jones industrial average rallied 127.83 points, or 1.2%, on Friday to end at 10,447.93. It shot up 4.4% over the last four days.

The Republicans might have preferred to enter election season with the economy sinking and stocks still mired in their recent malaise. But a few better numbers aren’t going to change the party’s message.

“Never before has the need for a fresh start in Washington been more pressing,” House Minority Leader John A. Boehner (R- Ohio) declared in a speech late last month.

That’s classic political rhetoric, but it resonates with many big-money players on Wall Street who increasingly have come to see President Obama’s policies on healthcare reform, financial regulation and taxes as ruinous for business and investor confidence.

When I asked Barry Knapp, head of equity strategy for Barclays Capital in New York, if his well-heeled clients wanted to see the administration essentially neutralized, he answered without hesitation: “Absolutely.”

Bruce Bittles, chief investment strategist at Milwaukee-based brokerage Robert W. Baird & Co., put it a little more politely.

“I think the administration has positioned itself as anti-business. It’s natural for Wall Street to want to see that changed,” he said.

In 2009 Obama and the Democrats had the advantage of a rebounding economy thanks in part to the $787-billion federal fiscal stimulus package.

Whether investors particularly liked the stimulus plan or not, they had to be happy that it helped restart economic growth — the promise of which powered the stock market rally that began in March 2009.

As for the financial sector, its bacon was saved by the taxpayer-funded bailout authored by George W. Bush’s administration and inherited by Obama. How could the money men complain?

For a while the country seemed to be climbing quickly out of the abyss. Private-sector job growth resumed last November and reached a net 241,000 payroll additions in April, the largest gain since March 2006. But since April, job creation has dwindled. On Friday the government said private-sector payrolls added a net 67,000 positions in August, better than expected but still woefully weak.

John Boehner says employers are “hamstrung by uncertainty.”

“The prospect of higher taxes, stricter rules and more regulations has employers sitting on their hands,” he said in his August speech.

This election was always going to be a referendum on Obama’s policies, but the recovery’s deceleration this summer has sharpened the debate.

The Democrats now look like they’re being panicked into action. Obama said Friday he would detail next week “a broader package of new ideas” to boost the recovery. The expectation is that the White House will focus on new tax cuts for businesses, although they’re likely to be modest in scope and impact.

And a much bigger tax issue looms: Congress must decide what to do about the Bush tax cuts on wages, capital gains and dividends, all of which expire Dec. 31. Extending them in full, without new spending cuts, would assure huge budget deficits for years to come.

For their part, Republicans are vowing to slash spending if they’re returned to power in Congress. Americans have heard that promise many times before, from both parties. But with the deficit expected to exceed $1.3 trillion this year alone, the GOP knows that many voters have a visceral fear of the debt-financed spending that exploded with the recession.

Patrick Becker Jr., a principal at Becker Capital Management in Portland, Ore., said he fielded worried calls last month from at least four individual-investor clients who have large sums with the firm and wanted to pull every dime out of stocks.

The concerned clients, he said, “were seriously questioning the direction of the country” because of record federal borrowing.

Becker said he talked them out of abandoning stocks, in part by correcting their impression of how much their portfolios were down this year.

“People’s perception is a lot worse than the reality,” he said. Despite the economy’s struggles since spring, the broad Standard & Poor’s 500 stock index is off just 1% year to date, after rising nearly 3.8% this week.

Some popular measures of investor sentiment have mirrored the grim view of Becker’s clients. A regular survey of independent market newsletter editors by research firm Investors Intelligence found that just 29.4% were bullish in late August — the lowest percentage since stocks bottomed in March 2009.

That’s the way it works with markets, of course: The moment when most people want to give up often is the turning point for prices.

Even as more individual investors lost faith in equities last month, the corporate world was signaling the opposite. The global value of announced takeover deals jumped to $286 billion in August, the most for any month in two years, according to data tracker Dealogic Inc.

The sudden wave of merger activity “tells you that stock prices are cheap,” said Robert Bissell, chief investment officer at Wells Capital Management in L.A.

Meanwhile, the Federal Reserve still is holding short-term interest rates near zero, and last month it revived its program of buying Treasury securities for its own account to try to pull longer-term rates lower.

All of this adds up to a huge amount of support for the stock market in the near term: “Double-dip” recession worries have eased, takeovers are surging, the Fed is helping on both ends of the interest-rate spectrum, and both political parties are telling the market what it wants to hear.

That doesn’t change the fact that the U.S. economy faces a long slog out of a deep hole as it works off the debt binge of the last 25 years. No matter how the November elections turn out, there are no miracle cures for what ails us.

But for now, investors who’ve been worried about an autumn calamity in financial markets should be feeling a lot less fearful.

tom.petruno@latimes.com