Fall Letter To Clients Part II

Shorter Term: Elections will produce gains.

Incumbents everywhere have large bull’s eyes on their backs. This year is producing a "this has got to stop" moment similar to elections that put Reagan and FDR in the White House and gave Republicans a house majority in 1992. Signs point to at least a change in control of the House and smaller Democratic majorities in the Senate. Analysts and pundits are all over with predictions of catastrophic Democratic losses. One estimate I’ve seen says Democrats could lose as many as 100 House seats!

Don’t buy this hype! Analysis of past elections similar to 2010 indicate that on average the party in power loses somewhere between 40 and 50 seats. This is enough to swing control to the Republicans. Yet Republican control or smaller Democratic majorities is irrelevant as the outcome will be the same.

Whoever controls the Senate will not have 60 seats and will lose the ability to end a filibuster by shutting off debate. Whether they lose the House or not, the Democrats will lose the ability to pass legislation at the will of the House Democratic leadership. Republican victories in one or both houses will likely not give them the votes to override presidential vetoes. Thus any agenda they bring forth will have to be the result of negotiations between the President and the Republican Congressional leadership.

What we do know is that Congress beginning in 2011 will initially be about the economy. The results will likely be more fiscally responsible and pro-jobs policies. A more evenly divided government will also check the more populist policies of the President. It is likely that much of this is already priced into stocks. Because of that I think it is possible stocks could either tread water or decline between now and shortly after the election. Don’t be surprised if the initial results are met with disappointment by investors until the realization that pro-economic growth candidates will be in charge of Washington in January. I think it is likely stocks will resume their rally into the year’s end once these results are factored in.

Tomorrow: Other reasons why stocks are compelling shorter term.