A Kerry Win Might Not Be So Bad

President Bush won Wall Street's affections early in his term by slashing taxes. With the recessionary economy he inherited clearly on the mend, most market participants are clamoring for four more years.

But while the big-picture economic news sounds uplifting, voters aren't feeling too secure about their own finances, and that has thrown the president's re-election prospects in doubt. Four months before the election, investors ought to prepare for the possibility of a victory by presumptive Democratic nominee John Kerry: It may not be as worrisome as many reflexively contend.

Even Republicans acknowledge that Bush needs to make a better case for himself on the economic front, where strength is evinced by record-setting corporate profits and nine months of jobs growth, very likely to be 10 after Friday's June employment report.

"By the economic growth we're seeing, you'd think Bush would be in good shape," said GOP pollster Robert Moran. "But there are a whole lot of other things at play, including a polarized electorate."

Fueling speculation about the possibility of a Kerry presidency, voters don't sound too happy with the status quo. Half of Americans disapprove of Bush's handling of the economy, according to a June Gallup poll. And one in five voters is afraid of losing his or her job in the next 12 months.

The violence-plagued occupation in Iraq has also seriously undermined voters' confidence in the president. Gallup's poll found that 54% of Americans believe the U.S. made a mistake in sending troops to Iraq.

The upshot is that fewer than half of Americans give a thumbs-up to President Bush's performance in office, a dramatic slump from a job approval rating near 70% just a couple of years ago.

At this stage, such weak support usually means a sitting president is headed for the unemployment line. "The last three presidents with numbers like this were Ford in '76, Carter in '80 and President Bush's father in '92," said John Zogby, head of an independent polling firm. All three failed their re-election bids.

This isn't to suggest that Senator Kerry is a shoo-in for the presidency. Many Democrats privately sigh that he has run a dull campaign, and incumbents enjoy built-in advantages.

In polls, Americans consistently prefer Bush on matters of national security, suggesting that if another terrorist attack occurred in the U.S. they might be inclined to rally around the commander in chief. (On the other hand, an attack could also spur questions about whether the president's policies have inflamed anti-American sentiments).

But at the very least, investors have begun taking more seriously the prospect that Kerry could prevail.

Gridlock Is Good

From Wall Street's perspective, the biggest knock on Kerry is that he would prefer to undo the tax cuts on capital gains and dividends enacted under George Bush, as well as the reductions in personal income tax rates. The Bush tax cuts were widely cited as a key contributor to the stock market's rousing gains in 2003, and some attribute the sideways slog in the first half of 2004 to concerns about Kerry's candidacy.

On the campaign trail, Kerry has also said he favors tacking labor and environmental rules onto free trade agreements -- proposals that rankle the laissez faire crowd -- and he's expected to push Washington regulators to be more aggressive in industries like pharmaceuticals, tobacco, auto and energy.

The sector most closely tied to the results of the election is pharmaceuticals, said Greg Valliere, chief political strategist for Schwab's Washington Research Group. There's speculation that Kerry might order his Health Secretary to allow cheap drugs to be imported from Canada a boon for consumers and a nightmare for drug companies, he noted.

Perhaps reflecting that risk, the Amex Pharmaceutical Index was down 3.1% year to date as of June 30 vs. a gain of 2.6% by the S&P 500.

Yet the veteran Senator has also offered up a handful of business-friendly proposals, pledging to cut the corporate tax rate by 5% and eliminate capital gains taxes for long-term investments in small business. He's managed to win support from former Bush backer and former Chrysler Chairman Lee Iacocca, as well as legendary investor Warren Buffett.

In fact, some Washington watchers think the so-called risks of a Kerry Presidency are overstated.

Given that the House of Representatives is all but bound to remain in GOP hands, Kerry would likely be hamstrung. "That's not a bad scenario at all for the financial markets. It means Kerry would have no chance to undo the Bush tax cuts," Valliere said.

Some believe the Treasury market would actually welcome the combination of a Democratic president and Republican-controlled Congress, since the resulting gridlock would reduce the possibility for big spending packages. (Indeed, such a political backdrop existed from 1994 to 2000, a glorious time for Wall Street and most investors.)

Even some conservatives grumble that Bush's tax cuts, expanded drug benefits for seniors and increased military spending have spurred a dramatic increase in the federal budget deficit, projected in March to be $477 billion in fiscal 2004, according to the Congressional Budget Office. (Granted, observers such as Valliere now believe the 2004 deficit will be under $400 billion and the CBO projects it will drop to $363 billion in fiscal 2005.)

Kerry has pledged to halve the deficit, and he's being advised by highly regarded former Treasury Secretary Robert Rubin, currently a director at Citigroup ( C).

"Net-net, Kerry -- even with a Democratic Senate -- would be quite okay for the bond market. And Kerry with a Republican House and Senate probably would be preferable for bonds," said Chuck Gabriel, senior Washington analyst for Prudential Securities.

All the handicapping, of course, doesn't mean Bush couldn't stage a comeback and win a second term. The bull case for the sitting president assumes that with the formal handover of power in Iraq completed, violence against U.S. soldiers there might ease up. Bush could then focus on the home front, arguing that an improving American economy will trickle down to help voters.

Pointing to the robust June consumer confidence data, GOP pollster Moran said: "Now it's almost a race against time on the economy -- does it continue to get better so voters don't switch to Kerry? If I could, I'd hold the election in January."

Indeed, there is often a lag time between improving economic data and voter sentiment, which seems to be the case right now. Many voters still say they are worried about job security -- an ominous sign for the incumbent. Over the past few months, the same voters who've named the economy the most important issue also say they're inclined to vote against President Bush, noted pollster Zogby.

Complicating matters, U.S. companies have been notoriously slow to add workers even as profits have surged, and many of the new service jobs pay less than the manufacturing work they're replacing. The outcome of the election, and the outlook for financial assets in the second half of 2004, will likely revolve around whether Americans start to believe they're taking part in the big-picture recovery they've heard so much about lately.

As originally published, this story contained an error. Please see Corrections and Clarifications.

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