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Elections Call for Investor Caution

NEW YORK ( TheStreet) -- The most important variable for the stock market has temporarily shifted from stock price valuation to politics. All eyes are on Tuesday's midterm elections, with investors optimistic that the Tea Party movement can bring gridlock to Washington.

We believe the Republicans will win the majority in Congress. But I want to be sure of such victory before I redeploy capital in the market, and I have been selling down positions, including Apple (AAPL - Get Report) 2011 options, as I discuss below.

The Tea Party movement is an interesting phenomenon. If the Tea Party had been in control during the financial crisis, then General Motors would be dissolved, the banking system would have been left on its own to collapse and the U.S. currency probably would have returned to the gold standard.

There is no question that this political movement is extreme. However, a dose of Tea Party mixed into a Republican majority in Congress with President Obama at the head of the executive branch could produce a wonderful tonic for the stock market.

If Obama shifts his policy towards the right as Bill Clinton did in 1994 and is successful at stimulating the economy through a more conservative agenda, the stock market should outperform the historical 21% average return for a third-year, first-term Democratic president. The stock market currently is banking on this optimistic scenario.

But what if all doesn't go as expected over the next few days? What if undecided voters rebel against the extremism of the Tea Party and Democrats overcome the odds to win both the House and the Senate?

This scenario is unlikely, but some Republicans have grown a little nervous about what is happening in California. Republican gubernatorial candidate Meg Whitman is getting buried in the polls by rival Jerry Brown, while Senate candidate Carly Fiorina appears unable to budge Democratic incumbent Barbara Boxer.

What election outcome is best for the stock market?

The GOP wins the House and Senate.
The Democrats maintain the House and Senate.
The GOP wins the House; the Democrats keep the Senate.
It doesn't matter who controls Congress.
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