What Does the Obama VictoryMean for Investors?

As President-elect Barack Obama and his supporters celebrate hiselection victory over Senator John McCain, investors around theworld are wondering how an Obama administration will impact theU.S. financial markets.

What Is the Broad Impact of Mr. Obama’s Victory?

Making any sort of prediction about the effects of the election can be very trickybusiness. Despite all of the prognostications and financial analyses that are apart of the process, at the end of the day, we believe the market impact of theelection will be less than most observers think. Like all elected officials, PresidentObama will focus on only a fraction of the initiatives he discussed on the campaigntrail. Additionally, exogenous events and surprises inevitably come up, many ofwhich have greater bearing than politics on the markets. In the current environment,this is perhaps even truer than ever. The economy is deeply troubled, marketshave been thrown into turmoil and government action has been unprecedentedrecently. In this sort of environment, discussions about how President Obama’senergy plans might impact the energy industry, for example, are taking a backseat to the broader issues of the credit crisis and economic recession. With thesecaveats in mind, we can make some observations based on President-elect Obama’spositions and can forecast some possible consequences.From a political perspective, it is important to remember that any campaign promisesmade by Mr. Obama eventually will have to be passed and funded by Congress.As a result, the outcome of the Congressional elections will likely play as largea role as the presidential election in determining how markets react. From theelection results that are now in, the Democrats have picked up several seats inthe Senate, although, from this vantage point, it appears they may be just shy ofthe 60-seat to 40-seat advantage that would give them a filibuster-proof majority.The Democrats have also picked up about 20 additional seats in the House of

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“Despite all of the prognostications andfinancial analyses that are a part of theprocess, at the end of the day, we believethe market impact of the election willbe less than most observers think.”“The outcome of the Congressionalelections will likely play as largea role as the presidential electionin determining how markets react.”

Representatives, further increasing their advantage there. While these majorities(and Mr. Obama's convincing margin of victory) should make it easier for PresidentObama to get his legislation passed, Democrats will not all move in lockstep onevery issue and the Republican Party will no doubt be able to continue exerting atleast some influence on the legislative agenda.

How Will the Economic Recession Impact Mr. Obama’s Plans?

Over the course of the campaign, the economy emerged as the key issue on whichvoters were focused. In fact, most pundits believe this focus was one of the mainfactors that tipped the election to Mr. Obama. At this point, we believe the U.S.economy is in a recession and that the recovery will be slow in the coming year.An environment of weak economic growth is likely to complicate matters for thenew Obama administration, and it will make it more difficult for him (and the newCongress) to enact some of the wholesale changes he has been discussing. Simplyput, there probably will not be enough money available to enact every new programMr. Obama has been proposing. As an example, we would point to Mr. Obama’sambitious healthcare program, which would provide low-income Americans withsubsidies to purchase health insurance. Such a plan would require significant taxincentives and/or spending increases, and while it would not be surprising to seesome sort of change in the way health insurance functions, the realities of the federalbudget will force the new administration to amend some of its plans. From aninvestment perspective, this again means that proposed healthcare changes areunlikely to impact the markets as much as some think, particularly in the short term.Also important in coloring this economic picture is the fact that the massive scaleof government intervention that has come about over the past couple of months(including the recapitalization of the banking system, nationalizing financialinstitutions, insuring deposits and the government’s purchase of equity stakes inthe nation’s banking system) is likely to limit the flexibility of the new administration.No doubt Mr. Obama would have preferred the opportunity to manage the creationof all of these new programs from the executivebranch, rather than inherit them ashe assumes office. While Mr. Obama is on recordas being largely in agreement withthe changes that have occurred, had the economicsituation not been so dire, hesurely would have preferred the opportunity to shapethese plans himself. In anycase, he will most likely have the chance to put his own mark on fiscal stimulusmeasures. There have already been discussions in Congress about the possibilityof creating a new fiscal stimulus plan. The outlines of such a plan are onlybeginning to fall into place, but such a plan could potentially include an extensionof jobless benefits, investments in infrastructure projects, a moratorium onforeclosures and extended or new tax credits for individuals or corporations. Itis also likely that some additional legislation focused on limiting the short-termrisks to home prices will be enacted. At present, the timing and scope of such aplan remains highly uncertain, but we would not be surprised if the governmentdelays action until Mr. Obama and the new Congress take their seats in January.“An environment of weak economic growthis likely to complicate matters for the newObama administration, and it will makeit more difficult for him (and the newCongress) to enact some of the wholesalechanges he has been discussing.”“President Obama will most likely havethe chance to put his own mark on fiscalstimulus measures. There have alreadybeen discussions in Congress aboutthe possibility of creating a new fiscalstimulus plan.”

What Is the Tax Outlook?

The economic issue of primary concern to most investors is what will happen onthe tax front. With the economy in recession, we think it is a foregone conclusionthat the government will be forced to borrow more money and to increase tax ratessimply to keep the government running. It is important to emphasize, however,that while tax rates will likely climb during President Obama’s administration,the repercussions are not likely to be as severe or as sudden as many fear. Therewill be little appetite for significantly raising taxes when times are so difficult formany Americans. As such, we would be surprised to see significant tax increasesenacted in 2009.Tax policies have been a centerpiece of Mr. Obama’s campaign and his plans (ifenacted) would have an impact on investors. Mr. Obama has been pushing for highermarginal tax rates for individuals in the highest tax brackets and reductions forthose in the lowest. Furthermore, he has proposed taxing “carried interest” fromhedge funds and private equity investments at marginal income tax rates. We dobelieve that overall tax levels will climb over the next four years, specifically forhigher-income Americans.Another tax issue weighing on investors’ minds is the outlook for continuing thefavorable tax treatment of long-term capital gains and qualifying dividends (the15% tax rate currently is set to expire in 2010). Mr. Obama has indicated that heplans to eliminate this favorable tax treatment (although he has stated that dividendincome for lower-income Americans would not be affected). It seems quite likelythat under an Obama administration, dividend income and capital gains tax rateswill increase for many, if not most, investors. By this measure, then, we think highertax rates for investors will be a headwind for equities (albeit not an insurmountableone) in the years ahead.We would point out, however, that while the likelihood of higher tax rates is anegative for some investments, municipals are one of the few areas of the marketlikely to benefit from increased taxation. As tax obligations increase, the tax-exemptnature of municipal bonds becomes more attractive to a wider audience. This, inturn, should help municipal bonds perform well relative to other areas of the market.

How Will Trade Policies Be Affected?

Another issue that has been receiving increased attention has been trade policies.While Mr. McCain tended to favor the types of expanded trade agreements thatwere a hallmark of both the Clinton and Bush administrations, Mr. Obama tendsto focus more heavily on protecting U.S. industries, and on environmental issuesand labor rights, when considering trade issues. Mr. Obama voted against theCentral American Free Trade Agreement (CAFTA) and during the election seasonquestioned the merits of the North American Free Trade Agreement (NAFTA).During President Obama’s administration, we expect trade to remain a hot-button issue and one that could have an impact on the markets. On balance, froman equity perspective, Mr. Obama’s potential trade policies may benefit traditionalAmerican manufacturing industries, but we would also point out that protectionistpolicies are, on balance, equity-negative, run the risk of slowing overall economicgrowth and can add to inflation concerns via wage pressures.“With the economy in recession, we thinkit is a foregone conclusion that thegovernment will be forced to borrow moremoney and to increase tax rates simplyto keep the government running.”“We think higher tax rates for investorswill be a headwind for equities (albeit notan insurmountable one) in the yearsahead.”“Municipals are one of the few areasof the market likely to benefit fromincreased taxation.”“Mr. Obama’s potential trade policies maybenefit traditional American manufacturingindustries, but we would also point outthat protectionistpolicies are, on balance,equity-negative, run the risk of slowingoverall economic growth and can add toinflation concerns via wage pressures.”