Editor's note: This column by Doug Kass is a special bonus for RealMoney readers. It first appeared on Street Insight on Nov. 8 at 8:17 a.m. To sign up for Street Insight, where you can read Kass' commentary in real time, please click here.

There's a new sheriff in Washington, D.C., and with it, there will be a reverberation in our economy and capital markets.

Control of the Senate remains statistically in doubt, as Democrats are leading close races in Montana and Virginia. In terms of the House, the Democrats are in control, gaining 33 net seats.

The election referendums on Iraq and the economy were clear, as poor management of the war and the general view that the lower- and middle-income classes have suffered at the expense of big business struck a populist chord with the electorate.

Given the sheer force and momentum of the bull market, even a Democratic "tsunami" will not immediately lead to a substantial market correction. While I believe the election's outcome will have a negative impact on equities over the short term (and that we have likely seen the market's highs for the year), we will probably see a slow and steady drip in equity prices through the remainder of the year, not a sudden, precipitous drop over the immediate few days and weeks.

In Monday's column, I highlighted the most vulnerable market sectors:

  • Defense ( PowerShares Aerospace & Defense ( PPA))

  • Pharma ( Pharmaceutical HOLDRs ( PPH))

  • High-end retail ( Retail HOLDRs ( RTH))

  • Energy ( Oil Services HOLDRs ( OIH))

I also outlined the sectors that will most benefit from the changing of the guard:

  • Environmental ( Johnson Controls ( JCI), Clean Harbors ( CLHB), Medis Technologies ( MDTL) and PowerShares WilderHill Clean Energy ( PBW))

  • Government-sponsored agencies ( Freddie Mac ( FRE), SLM ( SLM) and Fannie Mae ( FNM))

Importantly, a move toward protectionism and against trade agreements will also be unsettling to the markets.

Market participants' focus will quickly shift to the economy. That's where I disagree with most other bulls.

  • We are not in a mid-cycle economic correction. We are more likely at the end of the economic cycle. We are entering a period of blahflation, of lumpy and uneven growth characterized by stubbornly high inflation and tepid top-line sales growth. The consumer is spent-up, not pent-up, and housing is experiencing a hard landing, with attendant and broad economic ramifications.

  • The silver bullet of productivity is disappearing. Productivity growth is at its lowest level in nine years.

  • Inflation is well above the Fed's comfort zone. The rise in unit labor costs is at a 16-year high, and the trimmed mean PCE inflation rate is close to 3%. While the prices of crude and gas are way down, the prices of corn, soybeans, wheat, live cattle, orange juice and coffee are at multiyear highs.

  • Corporate pricing power is at a two-year low. While corporate profit margins are elevated to 50-year highs, they have already begun to fall for three consecutive quarters and are now vulnerable to a mean reversion.

  • The rate of growth in corporate profits has begun to decline. The bottoms-up forecasts for 11% to 12% profit growth in 2007 is a pipe dream. The bulls rave about third-quarter earnings growth, but I believe that on closer inspection, their optimism is misplaced. The third-quarter comparison was extraordinarily easy against the depressed Hurricane Katrina quarter, which was one of the weakest periods of profitability ever. As well, reported profits were inflated by corporate buybacks. Adjusting for those buybacks and seasonality, third-quarter 2006 earnings slowed to only a +11% rate, as compared with +15%, +17% and +20% in the previous three quarters.

  • Finally, complacency is copious. Disbelief has been suspended in an environment where fear and doubt have been driven from Wall Street. Just look at rising bullishness and several thin-reed indicators:

    • "Kudlow & Company" recorded its biggest year-to-year growth (134%) in the key 25-54 demographic of any show on its network, and just delivered its highest monthly ratings ever last month. (That is not a sign of market disinterest! This does not happen at market bottoms!)

    • Hedge fund Fortress L.P. has filed to go public.

    • There's a Pavlovian response to Jim "El Capitan" Cramer's "Mad Money" recommendations.

    • Consider the immediate (and wrong) response to headline earnings at General Motors ( GM), despite their poor quality and inclusion of nonrecurring tax benefits.

    • Or consider the reaction to Wal-Mart's ( WMT) analyst day announcement of a cut in capital expenditures. It led to a 7% one-day rise, only to be followed by a 10% swoon after poor comps were released days later.

    At time of publication, Kass and/or his funds had no positions in any of the stocks mentioned in this column, although holdings can change at any time.

    Doug Kass is general partner for two investment partnerships, Seabreeze Partners L.P. and Seabreeze Partners Short L.P. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box." Kass appreciates your feedback; click here to send him an email.

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