Given that many investment issues these days seem to hinge on the 2008 election, it is worth a preliminary look at electoral likelihoods and their broad investment implications. While no political indicators offer reliability, especially so long before the election, the best of an admittedly unreliable set are probably the on-line wagering odds. Since even these are tenuous, this early look at best can help with planning, if not with any immediate investment strategy making.
At present, the electoral consensus, as monitored by these odds, heavily favors the Democrats to take the White House in November 2008. In a generic race with just the parties and no individual candidates mentioned, the odds translate into a 55.5% chance of a Democratic victory compared with a 44.5% chance of a Republican victory. Given that there is considerable consensus among the Democratic candidates on some issues at least, it is possible to offer some guidelines about likely policy directions, even without considering the specific candidate.
Top marginal tax rates would almost certainly rise, especially if the Democrats keep both houses of Congress, which the online odds also suggest.
Since it is unlikely that the Democrats would go to extremes, even in a complete sweep, moderate tax hikes in and of themselves would stop neither the economy nor a stock market advance, should other fundamentals remain favorable at the time.
But tax hikes, even moderate ones, would detract from whatever strength would otherwise have existed.
Taxable bond yields would likely rise proportionally to any tax hike. Though conventional supply-demand analysis would look for rate relief, presumably because tax hikes would reduce government borrowing, such an effect would pale next to the demands from lenders for yields sufficient to secure their after-tax returns.
Of course, income tax hikes would have the opposite effect on municipal bonds. Higher taxes, especially in the top brackets, would make any tax exemption that much more valuable, allowing municipal yields generally to move in the opposite direction from taxable yields.
Chances are a Democratic administration would lend momentum to the efforts already developing to exert greater regulatory control over hedge funds, private equity funds and other unconventional investment approaches and, importantly, to subject them to higher tax rates. Already, Congress is considering legislation to force such funds to pay corporate tax rates, instead of the current lower rates, and to force the principals of these funds to pay income, instead of capital gains, tax rates on their returns from their ventures. There are other, admitted, vague measures also emerging in Congress. While George Bush remains in the White House, there is a natural stop to these efforts. Should a Democrat take the presidency after 2008, however, today’s proposals and other such tax initiatives would more likely become law.
Though it is doubtful that even a new Democratic administration would want to revisit Social Security or Medicare any time soon, a Democratic president probably would elevate health-care issues generally. Without a clear consensus among the candidates — much less in the party — it is pointless to speculate on specifics, but it is possible to suggest that such a Democratic-driven debate, quite aside from any specific proposals, would create volatility in health-care stocks generally and pharmaceuticals in particular, because they would likely occupy the center of any such debate.
Some have suggested that a Democratic administration might take action to support traditional defined benefit plans, as a way to supplement the increasingly inadequate Social Security system. While the tone in Washington might change, it seems unlikely that any administration would make such a move. For the Democrats, such a move might be particularly difficult, because it doubtless would require some additional breaks for the businesses offering defined benefit plans or, at the very least, some relief from the recently stepped-up burden imposed by the Pension Protection Act of 2006. Quite to the contrary of supporting defined benefit plans, this largely bipartisan piece of legislation made it more onerous for firms to maintain a defined benefit plan, complete with strict funding requirements, and actively encouraged the development of defined contribution plans with, among other things, easier enrollment rules.
Of course, a lot can happen between now and November 2008. And in the political realm things can change more quickly than in most areas of life. These wagering odds hardly show a history of stability themselves. In April, for example, this measure of consensus thinking gave about even odds to either party taking the White House. Certainly, the probabilities will change again, especially when the public knows the candidates better. It is clearly too early to make definite strategy moves. Hopefully, however, this analysis of odds and potential policy directions offers material for planning so that when the election’s results get clearer, investors can make their changes more nimbly.
Milton Ezrati is partner and senior economic strategist of Lord, Abbett & Co., Jersey City, N.J.
