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Embrace Equities Amid Election, QE2 Changes

BOSTON ( TheStreet) -- A Republican influx into the House and Senate would probably be cheered by investors hoping for political gridlock or a change in economic policy.

Stricter regulations in response to the subprime-mortgage crisis and the ensuing recession have painted Democratic leadership as anti-business. Further, ObamaCare and the threat of looming tax increases has aided a Republican resurgence. The GOP needs 39 seats to reclaim the House and oust Nancy Pelosi as speaker. Some analysts predict a 60-seat swing in Republicans' favor.

Jobs and the federal deficit are voters' top concerns, polls show. And fear of harsher regulations has made businesses hesitant to hire. Moody's (MCO) data indicate that S&P 500 companies are sitting on $1 trillion of cash. Liquidity-hoarding and cost-cutting have pushed profit margins near all-time highs and goosed the stock market despite the employment slump. So far, 259 of the 321 S&P 500 companies that have reported third-quarter earnings exceeded consensus targets. Just 194 beat revenue forecasts -- sales growth appears to be tapering. Without stronger demand, companies won't invest in new jobs.

A self-reinforcing cycle has created a so-called jobless recovery. The unemployment rate is stuck at 9.6% and is predicted to hover at that level unless additional economic stimulus is provided. Assuming the now-consensus scenario of Republican wins and a stalemate in Congress, the likely form of stimulus is an extension of the Bush tax cuts and a second round of quantitative easing, expected to be announced by Federal Reserve Chairman Ben Bernanke tomorrow.

Speculation has it that the Obama administration is now considering extending tax cuts for all Americans, but those for the wealthy would be temporary, either for one or two years. Some analysts argue that quantitative easing, a process through which the Fed purchases Treasuries to boost asset prices, including those of stocks, has already been priced into markets. The dollar has depreciated sharply in recent weeks and the S&P 500 posted an impressive 13% gain for September and October. Still, some see further upside in equities.

Barton Biggs, former strategist at Morgan Stanley (MS) and current manager of hedge fund Traxis Partners, last week predicted a 10% stock rally upon announcement of QE2.

Bond-fund manager Bill Gross of Pimco sees QE2 as the death knell for a 30-year bull market in fixed-income securities. Gross, though not predicting a sell-off in Treasuries, argues that yields have little room to decline without causing negative real returns for long-term holders. Thus, the case for stocks is difficult to refute. When the world's foremost fixed-income authority calls a top in the bond market, it's time for individual investors to embrace equities.
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