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Temporary Election Tailwinds

11/07/2010

The historic election of 2010 has passed with the Republicans picking up 6 U.S. Senate seats to gain on the still Democratic majority of 53 to 47 in the Senate.  On Monday, November 15th, when the U.S. Congress reconvenes, the Senate majority will immediately drop to 58 seats. The U.S. Congress currently has the Republicans assured of a 61 seat gain, taking majority control of the Congress 240 to 187 with 8 races still undecided. 

In the months preceding the midterm election, two major points seemed dominant for the capital markets. One, the historically positive data that shows, going back to the end of World War II, the S&P 500 Index average performance twelve months after a midterm election is above +15%.  More impressive is that the historical range during the twelve months following the election was +1% to +32%, with not one occurrence where twelve months out the S&P 500 Index was lower.  Second, look back three to nine months this year and reflect on the concerned conversation for aggressive end-of-2010 tax selling as the Bush tax cuts were set to expire.

With last week's election results, a strong near term tailwind is in place for the capital markets.

The tax selling headwind mentioned above has diminished.  In fact, the potential for an extension of the Bush tax cuts seems more likely.  In addition, the dividend tax rate will most likely remain at 15% instead of rising to the 40% marginal tax rate.  That will incentivize corporations to increase dividends. 

Also, enter some fresh, encouraging news that the Federal Reserve is preparing guidelines for stronger financial institutions to boost dividends or buy back shares. The Federal Reserve is clearly more confident in the capitalization levels of certain financial institutions, a clear reversal to the 2009 directive to "reduce or eliminate dividends."

So, in the wake of the election, the markets can expect a cordial November 18 Presidential meeting with Republicans; a likely extension of the Bush Tax cuts; possibly a short term extension of the emergency unemployment benefits; and some bi-partisan concepts surrounding energy, infrastructure, and trade policy, none of which should derail or unhinge the current positive momentum in the S&P 500 Index.

However, be aware that these are "temporary election tailwinds" for the 111th Congress convening on January 3rd.

Expect both sides to dig in their heels as January progresses. In fact, within the first six weeks of 2011, Congress must tackle the fate of the Government Sponsored Enterprises (GSE) - remember how it was pushed further and further back -  well, the time has come to deal with it. That GSE reform process in early 2011 could be a sign of more gridlock headwinds to come in early 2011.

As President Reagan accurately stated, "Trust but Verify."  I believe that applies to the notion of bi-partisanship extending beyond mid-January.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.