Will a Republican Sweep Make Stocks Surge?

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Richard Drew / AP

David Darst is no Tea Partier. Sometimes he even seems like the kind of guy who wants to spread the wealth around. “Wall Street needs to understand: for the bottom 90 percent of the population, the gains over the past 30 years have been minuscule,” says Darst, chief investment strategist at Morgan Stanley Smith Barney. “The middle class has been beleaguered and put-upon.”

He is also careful to preface his opinions of the Obama administration with an acknowledgement of the debt that financial institutions owe the public. “I tell my colleagues that the people of the United States bailed out the financial system,” Darst says. “Before we go saying the government is so mean, we need to remember that it was the politicians and Washington, the Fed and Treasury, that stepped up and saved us.”

But push Darst on his views of Tuesday’s midterm elections and the president’s relationship with Wall Street, and you will hear a familiar refrain: “What I hear from the administration when I listen to the radio, or when I watch TV, is the vilification and demonization of Wall Street and business.”

Darst, like others interviewed for this story, says that Wall Street is clamoring for a GOP victory that will force Obama to drop what Darst sees as an antibusiness agenda and “govern closer to the center.” Many bankers believe that the Democrats’ health-care and financial reforms have hobbled the recovery, making businesses too unsure of the future to hire new workers.

And it looks as though Wall Street may get what it wants. Polls show that Republicans are likely to take the House and may even grab the Senate. Will that make Wednesday a good day to have bets on the market? Is the Dow likely to surge? “A split government will look good to Wall Street because it means inaction on the part of the government, and everyone assumes that’s a good thing,” says Burt White, chief investment officer of LPL Financial.

But be careful before buying stocks in hopes of a second Republican revolution. The market moves on surprises, both good and bad, and while Wall Street may be happy with a GOP takeover of the House, that outcome is already expected, or “baked into the cake,” as traders like to say, and therefore probably would not move the market very much. What would cause the market to surge, analysts say, is a GOP capture of the House and the Senate. The coup would allow Republicans to undermine or try to repeal key provisions of financial reform and the health-care act. But even more important to Wall Street, a Republican sweep would mean few new laws up ahead.

“Wall Street is hoping that with GOP victory in the House and Senate, there will be absolute gridlock, with little new legislation passed, setting the stage for a one-term Obama presidency,” says Bernard Baumohl, managing director of the Economic Outlook Group.

But a victory in both houses is far from assured. Stats guru Nate Silver gives a GOP takeover in the Senate only a 9 percent chance. And Silver gives Democrats a 16 percent shot of keeping the House. That means, if we trust Silver’s numbers, there is a better chance of a “bad” surprise for Wall Street than a “good” one. “Everyone expects a GOP victory in the House, and if that doesn’t happen, we could see the market react very negatively,” says Baumohl.

It’s also possible that the market’s reaction will be a wash. Wall Street analysts and traders insist that the stakes for business are higher than usual in this election and that the market may react strongly to the results. But the last two major congressional upheavals moved the market only a bit, and not in the expected directions.

The substantial defeat Republicans received in the 2006 midterm elections, which turned both houses over to Democrats, could have been expected to make the Dow plummet, but instead it moved only slightly that week. Slightly up. And Newt Gingrich’s Republican revolution in 1994, which brought in one of the most pro-business Congresses in decades, did not cause a surge of market enthusiasm: the Dow dropped that week.

Whether the market rides up or down over the next few days, bankers say they are hoping that a Republican victory would cause Obama to soften his stances on issues like the scope of new financial regulations and letting some Bush-era tax cuts expire. “After Gingrich took over in 1994, you had some pretty conservative proposals coming out of the Clinton White House,” says Jack Ablin, chief investment officer at Harris Private Bank. “We are talking about meet-in-the-middle moderation.”

Whatever gripes big business may have about the tone and actions of the Obama administration, Wall Street hasn’t particularly suffered since the president took office: the Dow has risen almost 20 percent since the start of his term in January 2009, and last quarter profits were better than expected for 80 percent of the S&P 500 companies, reported Bloomberg BusinessWeek. Big banks are again raking in the cash, with the top five bringing in $15.2 billion just last quarter.

Wall Street may also be misreading the benefits of a GOP Congress. The strongest message from Republican candidates this cycle is not necessarily one that will be helpful to investors: cutting government spending. “The market is accounting for the tax cuts but not the spending cuts,” says White of LPL Financial. “Corporate America is already watching its purse strings, so without government spending, you are talking about very low GDP growth. That could be a real drag on the market.”

And with Republican leaders saying they want to cut the federal budget by $100 billion, Wall Street may come to regret getting its wish.

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