Bush Wins! Now What?
By Donald Luskin
November 5, 2004
I REST MY CASE. For months here I've been saying that the stock market wanted George Bush to be re-elected — and that it would soar if he were. On Election Day, when early exit polls made it look like John Kerry would win, stocks fell. But then Bush won decisively, and stocks have surged ever since.
And it's just beginning. Let's let two pictures tell 2,000 words. Have a look at these charts of the S&P 500 and the Nasdaq year-to-date. Both indexes bottomed on the same day — the day that George Bush bottomed in the polls. And now, with Bush re-elected, both indexes have broken out from downtrends they'd been stuck in all year. The S&P 500 even posted new highs for the year as of Thursday's close.
It's clear from these charts that we're in a new world. Why? Strangely enough, it's because the world has stayed the same. All year stocks have had to worry about Bush losing this election, which would mean that his pro-growth tax cuts on dividends and capital gains would be repealed. Now, with a clear victory and gains in both houses of congress, there's a good chance those tax cuts will be made permanent — and maybe even made bigger, too.
At the same time, the market will celebrate the fact that — if you will permit me to be blunt — the U.S. economy ducked a bullet by not having John Kerry in the White House. Say what you will about the social justice of Kerry's plans to raise taxes on the rich, to federally subsidize health insurance, and to legislate against outsourcing manufacturing jobs. Those things would be simply terrible for economic growth — and for stocks.
For the next few weeks, and probably through the end of the year, the market will rally as it absorbs the good news. There will be ups and downs, but as I've been saying in this column all along, look for a 20% or greater gain in the S&P 500 in the fourth quarter if Bush wins. Well, he won — and we're on our way.
So who will be the winners and who will be the losers? In some sense it doesn't matter. Stocks are going higher. Buy them. Hold them. Be happy. Still, there are some sectors that ought to do the best, and others that might get hurt. So let's drill down into the details.
First, let's dispense with a false myth that I've heard repeated over the last several days — the idea that stocks that pay big dividends ought to outperform the market, because of the anticipated continuation of Bush's tax breaks on dividend income. This was the same bogus argument that we heard in 2003 before that tax break was enacted — it was wrong then, and it's wrong now.
The price of a stock today is the discounted present value of all the dividends it will pay in the future, out to perpetuity. That's true even for stocks that don't pay dividends today (after all, presumably they are reinvesting that money today so that they can pay dividends some time in the future). That means that a cut in the dividend tax rate will affect all stocks equally, regardless of their current dividend payout or whether they even pay a dividend today. So don't run out and buy some stock just because it pays a big dividend.
Instead, focus on the stocks that are the most sensitive to economic growth. The secret sauce in Bush's tax cuts is that, by raising the incentives to take risk and invest capital, long-term economic growth will be encouraged. That means the tech sector, first and foremost. There's no other sector that's more sensitive to growth, and more connected to taking risk and investing capital.
It's no surprise that tech is one of the worst-performing sectors year-to-date. With Bush's re-election at risk, growth was put at risk. Now all that will start to run in reverse. Yes, I admit that so far, in the few days since the election, tech has lagged the overall market. But don't be fooled. Growth-sensitive tech stocks have been one of the best performers since the August bottom. Let them rest for a day or two — then, to the moon!
Another big winner will be the basic materials sector. With the Kerry protectionist threat taken off the table, a cloud has been removed from the growth prospects for China and India — and right now those are the fastest growing consumers of metals, cement, chemicals and all the other unromantic but essential building blocks of economic growth.
Same logic applies to health care. Kerry's strong advocacy of federally subsidized health insurance was the not-so-thin edge of the wedge leading to fully nationalized health care. That's a nuclear scenario for the sector, and now it's off the table.
Who are the losers — or at least, the ones that will win the least? No. 1 on my list is the energy sector. The massive run-up in crude oil prices has largely been the result of a speculative frenzy ignited by the fears of terrorism stimulated by the presidential election. Now that the campaigns are over and the fear-mongering can cease, look for oil to drop pretty quickly back to the $30s.
Energy has been, by far, the best performing sector this year. There's going to be some give-back. But it won't be fully proportionate to the drop in crude prices, because energy stocks never really fully absorbed the rise in those prices to begin with. And it's also the case that with inflation starting to brew, we can be sure that oil prices in the future will be, on average, higher than they've been in the past. So it won't be Armageddon for energy stocks — but it won't be a pretty quarter.
Utilities will be another losing sector this quarter. As confidence in economic growth returns after the election, the market will quickly conclude that interest rates are going to rise faster than anyone expects right now. For most stocks, that's a good thing. Rates are too low right now, and the first signs of a new inflationary episode are the logical result of that. But for utilities, it's poison — they are basically bonds, not stocks, and when interest rates go up, they will go down.
So my message to voters, now that the election is over, is this: forget about politics and start thinking about investing. If you voted for Bush, now you can be happy twice — once because your man won, and twice because your stocks are about to soar. If you voted for Kerry, don't hold a grudge — you'll get another shot in four years, and in the meantime, there's money to be made in stocks.
Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com1.
1mailto:don@trendmacro.com
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