Bush Or Kerry – Who’s Best For The Markets?

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
October 19, 2004

IN THIS ISSUE:

1. What The Stock Markets Are Telling Us

2. Post-Election Rallies When Democrats Win

3. Why Things Could Be Different This Time

4. The Window Of Opportunity In Stocks

5. Will Bonds Fare Better If Kerry Wins?

6. The (Severe?) Recession In Our Future

Introduction

Many investors are wondering which candidate – President Bush or Senator Kerry – would be better for the investment markets and their portfolios. President Bush has moved ahead in the polls once again, but with two notable exceptions, it remains a “margin-of-error” race. The two exceptions are the latest CNN/USA Today/Gallup poll (Oct. 17) which has it Bush 52 / Kerry 44, and the latest Newsweek poll (Oct. 16) which showed Bush 50 / Kerry 44. Otherwise, the race is still very close based on the national polls.

So who would be better for the markets? When asked, most people would say Bush, since he cut taxes and is thought to be for less government regulation and less intervention in the markets. Yet you might be surprised at some of the results when Democrats have been elected over Republicans, and when challengers have unseated incumbents. This week, we take a look.

We also look out over the horizon and find that a recession lies in our future, perhaps a severe one, and perhaps no matter who lives in the White House for the next four years. This will be the first of many discussions on the recession to come in the weeks and months ahead.

What The Stock Markets Are Telling Us

From Wall Street’s perspective, the Bush tax cuts on capital gains and dividends, along with the reduction in the income tax rates, were a big contributor to the markets’ rousing gains in 2003 when the Dow Jones and the S&P 500 gained over 28%. This year, however, the stock markets have been sideways to lower.

In fact, as this is written the major market indices are at the low end of the trading range, and some analysts fear that we will break out to the downside any day now. Many on Wall Street believe this is because John Kerry has pulled even with the President and even ahead at times in certain national polls. Kerry, of course, promises to roll back most of Bush’s tax cuts, including the reduction in capital gains and dividends tax rates.

So is the election really what’s driving stock prices lower? While the presidential race is not the only factor pushing stock prices into a choppy to lower trading range, it certainly is having an impact on investors around the country. It is often said that investors hate uncertainty. So, more than anything, the election uncertainty is prompting many investors to do nothing and just wait and see.

Of the many people I talk to, most believe that if Bush wins in November, the stock markets will launch into a new upward trend. Likewise, most folks I talk to believe that if Kerry wins, stocks will break out of the recent trading range to the downside. But how likely is either of those scenarios?

Post-Election Rallies After Democratic Victories

Let’s take a look at some recent history. The last two times the Democrats defeated a sitting Republican president were in 1992 (Bush, Sr.) and 1976 (Ford). In 1992, the S&P 500 fell 5% in the run-up to the election; in 1976, it fell 8% prior to the vote. As this is written, the Dow Jones has declined below the 10,000 mark again in a similar pattern.

Yet in both 1992 and 1976 when the Democratic challenger won, the markets staged a post-election rally. After Carter defeated Ford in 1976, the markets enjoyed a nice bounce in early 1977, but then went dead sideways for the next three years as the economy struggled. In 1992, when Clinton defeated Bush, Sr., the stock markets bottomed in October as Clinton pulled ahead and continued to climb in 1993.

In 1980, when Reagan defeated Carter, the stock markets had been moving higher. Yet for the next two years, in 1981 and 1982, the stock markets drifted lower. Not until late 1982 – two years after the election - did the equity markets bottom and begin what would be the greatest bull market in history.

In late 2000, as it looked like Bush would win over Gore, the high-flying stock markets peaked and turned lower. Equity prices fell even more amidst all the election uncertainty. And prices continued to plunge in 2001 during Bush’s first year in office.

So, based on this limited history, we might be unwise to assume that the markets will fall significantly if Kerry is elected, or rise significantly if Bush is elected. On the other hand, there are reasons to believe the next year will be the exception.

Why This Time Could Be Different

Whether you support President Bush or Senator Kerry, there are some very clear differences in what each would do if in the White House for the next four years. As noted above, Kerry has promised to roll back most of the Bush tax cuts, including the reductions in the capital gains and dividend tax rates. If successful, this will not be bullish for stocks and in fact, could be bearish.

Bush, on the other hand, will push hard to make his tax cuts permanent and perhaps reduce taxes even further. Bush has also proposed the creation of more tax-advantaged investment accounts (ie – retirement savings accounts). We can have a healthy debate over whether more tax cuts are a good thing or not, but Wall Street generally responds favorably to tax cuts.

In addition to the difference on taxes, Wall Street sees Bush as the more pro-business candidate. Bush pledges to enact tort reforms that would place caps on class-action lawsuits and medical malpractice suits. Because Kerry and Edwards are both lawyers, and Edwards is a trial lawyer at that, Wall Street worries that they would not be “business friendly.” Kerry is also seen as tougher on environmental issues, which would likely create more regulation and higher costs for many businesses.

Again, we can debate the pros and cons of these issues and differences, and many more, but I think it is fair to say Wall Street will more welcome a Bush victory than a Kerry win. This is why I continue to believe that the stock markets have a good chance to trend higher in the months ahead, and that the current dip is another buying opportunity.

The Window Of Opportunity In Stocks

When I recommended that investors move back to a fully invested position in stocks and mutual funds in March of 2003, just before the war in Iraq began, I anticipated several things. First, that the invasion of Iraq would go well, at least in the initial stages. Second, that the economy would continue to recover, as it has. And third, that stocks could trend higher for the next couple of years.

[If you took my advice back then, you are still well ahead. The S&P 500 was in the range of 800-850 at the time, and today it is above 1,100.]

As I have discussed in recent weeks, most of my valued sources and most economists agree that the economy will continue to grow at a healthy rate (3-4% or better) over the next year, barring a major negative surprise such as another terror attack on our soil.

Given this outlook, and the fact that interest rates are still very low, I continue to believe that stocks have a window of opportunity over the next year or so to move higher. I believe that if President Bush is re-elected, we could see stocks begin to trend higher again.

Actually, it could happen regardless of who wins the election in November. The country is so ready for all of the vile rhetoric and campaign rancor to be over that stocks might rally no matter who wins.

How much higher might stocks move? I don’t know. Yet the equity markets have surprised on the upside many times over the last 20+ years.

For the record, I do not expect a multi-year bull market to unfold anytime soon. In fact, I don’t expect the markets will make it to their all-time highs seen in late 1999 or 2000 again anytime soon. But if the S&P 500 were to move up to 1,400 from 1,100 presently, that’s definitely a move worth participating in.

Bonds Will Fare Better If Kerry Wins?

While most of the pundits seem to believe that stocks will do better if Bush wins, many also seem to believe that the bond markets will do better if Kerry wins. The arguments generally fall along two lines of thought. First, if Kerry raises taxes as promised, that would serve to slow down the economy. If the economy slows down, then interest rates won’t rise as much as currently expected, and that would be good for bonds.

Second, somehow there is the feeling among many that Kerry would significantly reduce the budget deficits over the next four years. Thanks to Bush’s acquiescence to big spending, the Democrats are now seen by many as the party of fiscal reform. What a switch!

The truth is, neither candidate will cut the budget deficits significantly in the next four years. According to the Congressional Budget Office, the deficit is projected to remain above $400 billion a year until at least 2008 unless something major is done to reduce it.

Both candidates are promising to spend much more than they can pay for, so if anything, the deficits will continue to rise, not fall. I don’t see this as a windfall for the bond markets.

Defensive Investing With Professionals

Obviously, there’s no guarantee that the S&P 500 is going to 1,400 as noted above, or that it’s not going to fall through the floor. Likewise, there is no assurance that the bond markets will rise if Kerry is elected; the deficits may rise regardless of who wins the election; and thus there is the real possibility that bonds could suffer either way.

As we all know, we live in a high-risk world. While we may think that the stock markets will move higher in a Bush second term, or that bonds might perform well in a Kerry administration, we all know that terrorism could change everything. We saw what happened to the markets just after 9/11.

Even in the absence of additional terrorist attacks, there are no guarantees that the economy will continue to grow at a healthy pace. In fact, there are arguments that it will not continue to grow strongly if taxes are raised. And as I will discuss below, there is a recession in our future.

Because of these uncertainties and others, I have the bulk of my investment portfolio managed by professionals who can “hedge” their positions if negative surprises occur.

There are professional money managers out there who have time-tested systems to hedge their positions should the markets turn decidedly lower. The managers I recommend in this uncertain environment also have the flexibility to move partially or fully to the sidelines (money market funds) if market conditions so warrant.

I invite you to see their actual performance records over many years. Or call us at 800-348-3601 for more information.

The Recession In Our Future

A Republican friend of mine recently told me that he hopes John Kerry wins the election. Why? Because he believes we will hit the next recession sometime in the next four years. He thinks it will be better for the Republicans in 2008 if the recession occurs on Kerry’s watch.

I happen to agree that we will see a recession sometime in the next four years, regardless of who is in the White House. And it may be a bad one, as I will discuss in coming weeks.

With budget deficits of $400-$500 billion a year (regardless of who wins in November), and with household debt at record levels, the next recession – whenever it happens - is almost certain to be a serious one.

Predicting the timing of a recession well in advance is very difficult. While most economists and market analysts predict that the economy will grow by 3-4% or better over the next year or so, you rarely hear predictions beyond 2005. That’s because beyond the next year, the economic outlook is murky at best.

Will the next recession unfold in late 2005 or in 2006? Or in 2007? No one knows for sure. But I believe it is fair to assume that there will be another recession sometime in the next four years. And there are plenty of reasons to believe that the next recession will be a serious one.

Conclusions

There are arguments that a Bush win will be better for stocks, but recent history doesn’t support that view. On the other hand, if Kerry wins and raises taxes in late 2005 or 2006, that could be very negative for stocks. There are arguments that Kerry would be better for bonds, on the assumption that he will cut the deficits significantly. The truth is, neither candidate is likely to cut the deficits significantly anytime soon.

There is a window of opportunity for stocks to perform well over the next year or so, in my opinion, particularly if Bush wins, but perhaps regardless of who wins the election. This is why I view the current dip in the equity markets as another buying opportunity in stocks and mutual funds.

Yet in this high-risk world we are in, I have the bulk of my investment portfolio (stocks and bonds) managed by professionals that have the ability to hedge their positions and the flexibility to move to the sidelines if economic and/or market conditions warrant. Money managers who can do this successfully are few and far between, but they are out there if you know where to find them.

A recession lies in our future, no matter who wins the election, and it may be a serious one. The popular “buy-and-hold” investment strategy will be a disaster in the next recession, if history is any indicator.

You may agree or disagree that stocks have a window of opportunity over the next year or so. You may decide to participate, or you may remain largely on the sidelines along with droves of other investors who are parked in money market funds earning next to nothing.

Whatever you do, I recommend using the months just ahead to move to a more flexible investment strategy that can change as the economic and market environments change. We can help you do that.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

More on the Colorado Electoral College initiative.
http://www.csmonitor.com/2004/1019/p08s03-comv.html

Three Baby Booms coming our way – an interesting read.
http://www.nytimes.com/2004/10/17/opinion/17friedman.html?oref=login

A funny debate spoof on both candidates.
http://www.nytimes.com/2004/10/16/opinion/16brooks.html?oref=login