Voters dismayed at the government’s handling of the war in Iraq are widely expected to elect enough Democratic representatives Tuesday that control of the House of Representatives will shift away from Republicans for the first time since 1994. Control of the Senate remains up for grabs, with odds in favor of the Republicans maintaining control heading into the vote.
Analysts said a Democratic takeover of the House is largely expected, however, and won’t come as a shock to investors. “A growing dissatisfaction with the current political leadership has been evident for some months, and I believe investors are anticipating a shift in power in at least one house of Congress,” wrote Kenneth Tower, chief market strategist at CyberTrader, in a note.
Indeed, many investors say the most likely outcome of a split Congress is gridlock. To Wall Street, that means major legislation imposing harsh regulations on industry is even more improbable than if a single party wields the controls of government power.
“[T]he market favors perceived gridlock, and that expectation is being built into” the price of stocks, wrote Marc Pado, U.S. market strategist at Cantor Fitzgerald, in a Tuesday note.
The rally may also show investors simply aren’t paying much attention to the election, analysts said. “I don’t think the market is particularly concerned about the outcome [of the election], although there are certain sectors that will be affected,” said Russ Koesterich, senior portfolio manager at Barclays Global Investments.
Mr. Koesterich said sectors that could be impacted by Democratic leadership in Congress include pharmaceutical stocks, as legislators try to push down the price of certain drugs, and utility companies, which would be impacted if the dividend tax cut isn’t extended beyond 2010, when it’s currently set to expire.
The upsurge by stocks also indicates investors are growing confident in the strength of the economy and corporate profits after a brief scare sparked by a weaker-than-forecast report on third-quarter gross domestic product. Tepid reports on manufacturing, consumer confidence and worker productivity also raised concerns that the economy is slowing faster than previously thought.
But last Friday’s October payroll report indicated underlying strength in the jobs market, as the unemployment rate slid to a five-year low. The payroll report reversed expectations that the Federal Reserve would begin to cut interest rates early in 2007 to cushion the economy from a slowdown triggered by the weakening housing market.
Sandra Pianalto, president of the Fed’s Cleveland branch, warned late Monday that policy makers may have to boost rates if the pace of inflation doesn’t wane soon, although she added that she doesn’t believe inflation will accelerate.
Bonds rallied as traders shrugged off Ms. Pianalto’s comments on rates. The 10-year Treasury note gained 14/32 point to yield 4.645%. Oil prices declined on the New York Mercantile Exchange, falling 96 cents to $59.06 a barrel.
While traders were initially troubled by prospects for a less-lenient Fed, the focus has shifted to the view that the economy remains on solid footing, and those hopes have sent stocks higher in the past few days.
To be sure, not everyone thinks the economy is out of the woods yet. Barry Ritholtz, chief investment officer of Ritholtz Capital Partners, thinks the economy has a greater-than-50% chance of sliding into a recession in 2007 as the negative effects of the cooling housing market spread. “Everything is pointing toward a significant slowdown, not a minor cooling or midcycle pause,” he said. “All the data is pointing to a major slowdown and the market cares not a whit.”
Investors weighed some mixed news on the housing front Tuesday. Toll Brothers cut its delivery guidance for fiscal 2007 and reported tepid fourth-quarter revenue. And late Monday, H&R Block said it’s considering a sale of its sub-prime mortgage business, which has suffered from higher interest rates, past-due mortgages and softening loan demand.
In major market action:
Stocks rose. On the New York Stock Exchange, 2,041 stocks advanced and 1,184 declined on volume of 1 billion shares.
Bonds advanced. The 10-year note gained 14/32, or $4.38 for every $1,000 invested, to yield 4.645% Tuesday. The 30-year bond was up 25/32 to yield 4.738%.
The dollar weakened. The euro traded at $1.2803 from $1.2723 Tuesday, and the dollar was at 117.47 yen from 118.29 yen.
Write to By Scott Patterson at scott.patterson@wsj.com
gary says