How Will Stocks, Bonds And Currencies Respond To Election Results?

By Kathy Lien
With less than 2 weeks until the US Presidential Elections, traders are looking for clues as to how stocks, bonds and currencies may respond to a Bush or Kerry victory. With neither of the candidates having a significant lead over the other, the one thing that is clear based upon each candidate’s policy stances is that a Bush victory would be favorable for stocks while a Kerry victory would be favorable for bonds. As for currencies, it is a matter of which candidate is worse for the dollar.

Bush Positive For Stocks
As the Republican candidate, President Bush’s policies are more favorable for US corporations and the equity markets. He advocates maintaining the 15% tax rate on dividends and capital gains while Kerry advocates raising taxes on long-term capital gains from 15% to 20% and the top rate on dividends from 15% to 39.6%. Bush’s more favorable treatment of capital gains is supportive for stocks since it would reduce the after tax returns on equity investments. Although we do except the indexes to rally on a Bush victory, here is how certain sectors may respond:
Positive For Defense – More specifically, A Bush victory would be very positive for defense stocks. As an advocator of maintaining vigilance in the War on Terror, Bush is expected to maintain the current level of defense spending. Although it is unlikely that Kerry will make significant adjustments to defense spending, his shift of focus could impact stock prices. Kerry’s advisers say that his administration will focus on boosting military pay, troop levels and readiness and his voting records in Congress indicate that he is against a number of major weapon plans and increased missile defense spending. This will be particularly negative for the stocks of major defense companies whose plans to build a $54 billion US missile defense shield could be thwarted.
Positive For Healthcare – Health care stocks will also respond favorably to a Bush victory. The Kerry camp supports a larger role for the government in insurance and drug costs. They advocate cutting prescription drug costs, allowing uninsured Americans to participate in a government sponsored plan and possibly permitting re-importation of drugs from Canada. Overall Kerry supports a higher minimum wage, which could also hurt labor-intensive industries.
Negative For Middle and Low End Retailers – Retailers targeted at middle and low-end markets could sell off on a Bush victory. The spending power of middle class consumers and the higher minimum wage for lower-end consumers would be boosted by Kerry’s tax breaks, which over the medium term would benefit low-end retailers.
Negative for Environmental and Technology – A Kerry victory would also be potentially positive for environmental and technology stocks. He advocates more focus on environmental and alternative energy programs as well as investing more money into “industries of the future” such as nanotechnology.
Kerry Positive For Bonds
As the Democratic candidate, a victory by Kerry would be positive for US Treasuries. Kerry’s policies are more fiscally conservative and he has ambitious plans to halve the deficit over the next five years. Bush also promises to halve the deficit over the same time frame, but Kerry’s plans to reverse President Bush’s tax cuts and to raise taxes on long-term capital gains and dividends may give him a head start. However from a bond market perspective, Kerry’s bid to reverse Bush’s tax cuts could also crimp consumer spending and slow growth, which could encourage investors to shift from stocks to bonds. A slower pace of growth may also force the Federal Reserve to maintain a looser monetary policy while a successful reduction in the deficit would mean that the government may reduce the supply of government debt – lower rates or a slower tightening cycle would also help to boost Treasury prices.
The Dollar Implications Are Less Clear?
Bush Is Bad For The Dollar – Taking a look at history, Republican Presidents tend to be more positive for the dollar than Democratic Presidents. However, given the stagnant labor market, the Bush Administration would be ill advised to do anything other than maintain the “soft dollar” policy that has been enhancing the competitiveness of American manufacturers and multinationals. Furthermore, Bush’s bid to make permanent the tax cuts from his election-year plan threatens to erode confidence in the greenback by creating persistently wider fiscal deficits. The 10-year cost of such an extension could be between 1 and 2 trillion dollars. Although the President has promised to cut the federal budget deficit in half over the next five years, making the tax cut permanent would make it very difficult for him to achieve this goal. Although some may argue that the less negative dollar ramifications of the incumbent President’s reelection may be less applicable in the upcoming election, markets (and the dollar) have generally welcomed a steady financial policy.
Kerry Would Be Worse – However, a Kerry victory may be even worse for the dollar. New presidents tend to often administer “bitter medicine” to correct economic problems once they take office in what may be taken as “correcting the previous administration’s problems,” creating uncertainty and hurting growth. Although he advocates more fiscal responsibility, his policies may lead to looser monetary policy and hence a slower pace of rate hikes. As mentioned earlier, his policies could also threaten growth and external confidence in the dollar. Furthermore, Kerry is more supportive of protectionism and barriers to free trade. As for offshore outsourcing, Kerry has come out against its use in government contracts and favors a Consumers’ “Right to Know” on Call Center Workers policy aimed at stifling the movement of these jobs abroad. The allure of the US economy and its markets stems from their flexibility, adaptability and openness. Protectionism is an antithesis to all of this, and the dollar tends to deteriorate when financial markets sense even a trace of it. It is important to mention that some international investors believe that Kerry’s foreign policies would be more inclusive and viewed positively. This could potentially reduce some of the risk premium that foreigners may have placed on US assets.
An Expectations Game
Fundamentals dictate that the dollar will remain on a downward path regardless of a Bush or a Kerry victory. Expectations – whether they be for the “soft dollar” status quo in the event of a Bush win, or for stricter tax laws for corporations under a Kerry victory – should contribute to a lower dollar in the run-up to the election. But the issue is one of degree, not direction. The candidates are running neck and neck following the third and final debate and it is still unclear who the winner will be. This means that positioning remains skeptical and the market does not have enough information to discount a victory by a particular party prior to the election. As with any economic data releases, when the majority of the market is biased in one direction, traders have ample time to adjust their positions, which means that there is generally a muted dollar reaction when the release is issued in line. However, when the market is divided as to the likely outcome, the dollar’s response following the actual release tends to be more dramatic. The same will be the case for the outcome of the Presidential election. With the market divided on the possible winner, the only thing that we can be assured of is interesting price action afterwards.
Source: Yahoo Finance

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