After months of anticipation and uncertainty, incumbent George W. Bush managed to squeak out a victory over Sen. John Kerry to earn a second term as U.S. commander-in-chief, a decision that drew applause from Wall Street last week. Now that the dust has cleared, the question is what does a Bush win portend for the market and the economy?
Investment firm U.S. Bancorp Asset Management, advisor to the First American Funds, projects that a Bush victory will send the stock market higher through the end of the year as cash moves off the sidelines. The Minneapolis, Minn.-based company had been predicting that simply getting the election over with would be a positive for the market.
"Our view has been that the uncertainty surrounding the election has led to cautiousness on behalf of investors and that the risk premium built into equities has been very, very wide," said Chief Investment Officer Mark Jordahl, on a conference call Wednesday. Consistent with his bullish view on stocks, he is advising clients to overweight equities. "There continues to be upside in the equity markets as the market fully discounts the appropriateness of putting some of this uncertainty behind us," Jordahl said.
Indeed, the major indices responded in kind to the news as the Dow Jones Industrial Average and the S&P 500 each sprinted to a 1% gain in the trading session immediately following the election while the tech-laden Nasdaq tacked on 0.98% in the aftermath. Volume was robust as well with a combined 3.7 billion shares changing hands on the Nasdaq stock market and the New York Stock Exchange.
Certain sectors stand to perform well during Bush's second term including defense and aerospace names, energy, healthcare, HMOs and pharmaceuticals. The Republican victory could provide the pharmaceutical sector a real shot in the arm, abating fears that a Kerry administration would impose tougher price regulation on drug manufacturers. Oil drillers could also benefit, as a Republican-dominated Senate looks to revive legislation to authorize drilling in the Arctic National Wildlife Refuge.
While U.S. Bancorp predicted a rally in stocks irrespective of who won the election, the firm argues that a Bush rally would far outpace a Kerry rally. The biggest difference in the policies of the two presidential candidates as it relates to the financial markets is the Bush tax cuts, which have eased the tax burden imposed on capital gains and stock dividends. Had Kerry been elected, he would have likely allowed those provisions to sunset or eliminated them altogether. Bush, on the other hand, plans to make the tax reforms permanent, which would serve as a boon for large-cap, dividend-paying stocks.
"We calculate that to be worth about 4% value to the market," said David Chalupnik, head of equities. "We still would have expected the market to rally through year-end, but under Kerry, it would have been much more muted." He expects a 4% to 5% rally in the market between now and year-end and remains bullish on the prospects for 2005. He noted that all the favorable "economic ingredients" are in place to support a rally in stocks including low inflation, low long-term interest rates, trend-like GDP and strong earnings growth, calling it an environment that's "quite constructive for equities."
In terms of which investment category will produce greater returns, U.S. Bancorp favors large-cap stocks heading into the new year. Chalupnik noted that, historically, small-cap stocks perform better immediately following periods of slow economic growth or a recession. But eventually, large-cap stocks catch up and surpass small-cap stocks as the Federal Reserve raises short-term interest rates. A tightening of monetary policy by the Fed tends to have a prohibitive effect on small-cap offerings, increasing their costs. Meanwhile, large-cap stocks generate more free cash flow and are less dependent on the financial markets.
The firm's earnings growth forecast for 2005 calls for 7% growth for the S&P 500, which would price the market at $71 a share. Currently, the market is trading at roughly 16 times projected 2005 earnings. Chalupnik contends that the market would be fairly valued at 18 times earnings, which would peg the S&P 500 at about 1260. However, if the market really takes off and trades at 19 to 20 times earnings, he would recommend clients take money off the table because valuations would then be overblown.
Far more troubling than inflated valuations is the impact of higher crude oil prices. Historically, for every $10 increase in oil, there is a negative impact on the nation's gross domestic product of 0.4% and a 0.7% hit for worldwide GDP. Chalupnik notes that higher energy prices would dampen consumer demand and squeeze corporate profit margins, which ultimately would slow economic growth.
Some Bush critics argue that Kerry would have prevented inflated oil prices had he been elected by tapping into the Strategic Petroleum Reserve, a move the Bush administration views as an emergency recourse. U.S. Bancorp, however, said that releasing some of the reserves would only serve as a temporary salve and that it would not remedy the problem of high demand and a tightening supply in the oil sector. "Energy would have stayed at elevated prices had Kerry won," Chalupnik said.
In Russia, oil giant OAO Yukos is facing potential bankruptcy as a new tax bill has exacerbated its debt woes to the tune of $17 billion in back taxes. Yukos generates more than two million barrels each day and recently suspended rail-borne exports to state-owned China National Petroleum Corp. In Iraq, militants have threatened to strike oil installations and government buildings if the Americans launch a full-scale assault on the city of Fallujah. Exports from northern Iraq have already been suspended for up to 10 days after insurgents blew up a pipeline there.
Another perceived threat to a rally in stocks is the health of the job market, which has been creating 170,000 jobs per month through September. Chalupnik characterized labor market conditions as "not incredibly robust but not terrible." In 2005, it figures to play a more significant role in how the market performs as the Fed looks to raise interest rates.
"As fiscal monetary stimulus recedes, job creation is going to be very important to propel growth in 2005," Chalupnik said. "Our expectation is that job creation will continue at a pace similar to what we've seen this year and that's consistent with trend-like 3% GDP growth.