On the Street, Blessed Be Gridlock

With the presidential race as tight as a corset, with the politicians getting angry as roosters, with America on the edge of its seat, Wall Street can find succor in two things.

First, with the Florida votes getting recounted, there is the glimmering hope that all the damn metaphors we've been hearing lately will -- like the rain, like the river that meanders, like the longest journey -- come to an end.

Second, there's a good chance that nothing much will get done in Washington over the next two years. Broadly put, that stands to be good for the markets, as it should keep well-intentioned politicians from monkeying with economic success. But on a sector-by-sector basis, forecasting who will benefit and who won't is far trickier. Witness Wednesday's tech selloff.

Blood and Gore

"America voted to sustain prosperity, not make any major changes," says Morgan Stanley Dean Witter chief U.S. economist Richard Berner. "I think this is a vote for gridlock."

The vote for gridlock would apply most should Vice President Al Gore somehow take Florida. With Republicans maintaining control of Congress, Gore would be hard-pressed to pass any major new spending packages. By the same token, he would be inclined to veto any major tax cut. Thus a Gore victory would maintain the economic status quo while continuing to pay down the deficit, an important priority on rate-obsessed Wall Street.

Ignoring the sectoral oddities of what might happen to drug stocks or tobacco stocks or Microsoft (MSFT), that scenario is pretty market-friendly. It's a recipe for lower bond yields, a tight fiscal policy and a benevolent monetary policy. It is for this reason that Treasury futures mounted a significant rally last night when the major television networks said Gore had won Florida, and then promptly gave it back when Florida's outlook changed.

Yet with the race so tight, and with Gore the likely winner of the popular vote even if the Florida results stand and Texas Gov. George W. Bush wins the Electoral College, a Bush presidency would hardly be seen as carrying any policy mandate. Combine that with the Republicans' slight House majority and a split-down-the-middle Senate (with the deciding vote going to the incoming vice president), and it seems unlikely that we're going to see any major Bush initiatives.

Standing Still

"The conclusion the markets would draw would be that you're not going to get major policy shifts, either for the positive or the negative," is how ISI political strategist Tom Gallagher put it in his firm's postelection conference call. "Anything that happens is going to be the result of a compromise. That's going to keep the policy shifts very centrist."

Again, the most immediate broad market effect here is in the Treasury market. Because a deep Bush tax cut is unlikely, the national debt will get paid down more quickly. Still, it must be acknowledged that Bush -- now the odds-on favorite -- would be dealing with a friendlier Congress than Gore. Some form of tax cut seems likely.

"If the count goes Bush's way, we still essentially have a Republican government," says J.P. Morgan equity strategist Doug Cliggott. "That makes it a pretty high-probability outcome that fiscal policy is going to be easier than it was in the past four years."

Besides the obvious effect on Treasury yields, an easier fiscal environment also stimulates the economy. When the government does that, the Federal Reserve tends to get more restrictive, hiking interest rates. That's basically what was happening for much of the 1980s.

Broad Strokes

Obviously, with a fairly gridlocked government we're not going to see a return to a 1980s economic environment. Higher yields and a faster economy most obviously benefit energy companies, because oil prices go up when the economy quickens, and there is little correlation between oil prices and Treasury yields. Lo and behold, the Philadelphia Stock Exchange Oil Service Sector Index jumped 3% Wednesday.

On the negative side, a rising-rate environment obviously doesn't favor financial companies, which is one reason the Philadelphia Stock Exchange Bank Index slipped 2%.

The other sector that might not do as well under a united Republican government is technology. First, tech stocks tend to suffer (as do most sectors) when rates go higher. And second, in a fiscally stimulative environment, techs potentially might not see the same kinds of revenue gains as other sectors.

"One of the rules of thumb in economics is when you get tight fiscal policy, that tends to encourage business investment," says Cliggott. This was a hallmark of the 1990s, when the government reduced spending and capital expenditures surged. Quite the opposite happens during fiscally loose times. In what is known economically as "crowding out," a greater supply of government bonds is competing with corporate bonds. The resulting higher yields mean that corporations simply do not issue as much debt, which means they raise less money, which means that they must put off capital-intensive projects. The kicker is that technology makes up for about 60% of U.S. companies' expenditure on new equipment, according to the latest gross domestic product report.

Sound abstruse? Sure. But the Morgan Stanley Dean Witter High Tech Index was down 4.9%.

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