Stocks Handcuffed if Rove, Libby Indicted

How the Markets Could Lose

Fast forwarding to today, there is no telling if Fitzgerald's investigation into a conspiracy to leak secret CIA information to punish a Bush administration critic will yield indictments. But if they come, there are two ways for the administration, and the market, to lose.

If Rove is targeted, President Bush either loses his indispensable political strategist or he spends a lot of political capital defending him and keeping him in the White House. Take your pick -- they're both bad outcomes. As ISI Group analyst Tom Gallagher said in a report last week, "Wagon trains pulled into a circle don't make a lot of forward progress."

The investigation of GOP lobbyist Jack Abramoff and the indictment of Rep. Tom DeLay are already causing a lot of problems in Congress, and dragging Rove or Libby through the courts would make matters worse. As noted by Gallagher, here are some possible effects on businesses and stocks if Congress is distracted:

The lower tax rates on dividends and capital gains could "sunset," i.e., lapse without being renewed.

Republicans could head into the midterm elections with a risk of losing their congressional majority, which would potentially have repercussions in such areas as health care.

The upheaval would probably lead to policy mistakes that could allow the balance of power to shift from a strong White House to resurgent Democrats in Congress. In compromises from a weakened position, you could see Bush accept more foreign trade restrictions, for instance, which the market does not like.

This is all taking place against a backdrop of other factors that investors fear. One of the key elements, of course, is higher short-term interest rates. While many appear to believe that the Federal Reserve is likely to halt its rate-hiking campaign soon, I have my doubts.

It's important to note that the Weekly Leading Index of the Economic Cycle Research Institute, which has done a great job of forecasting recessions over the past two decades, does not show a recession on the six-month horizon. That's good news for the economy but bad news for people who think weakness will spur the Fed to stop raising rates.

An improved economy gives the Fed free rein to hike. At the same time, the Future Inflation Gauge of the ECRI is at a five-and-a-half-year high. Put those two together, and you pretty much have to view the Fed to be in inflation-fighting mode, which means it will keep raising.

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Jon Markman, writer of TheStreet.com Value Investor, is the senior investment strategist and portfolio manager at Greenbook Investment Management, a division of Greenbook Financial Services. Separately, he is publisher of StockTactics Advisor, an independent weekly investment research service. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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