Business Analysis: Wall Street points to a Kerry victory but fears a disputed outcome

As Americans go to the polls, what the markets want most is a clear cut winner
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Forget Ohio, Florida, Pennsylvania and Wisconsin. The best signal to the outcome of today's US presidential election has already been sent by the stock market.

According to a recent study by Wall Street's bible, the Stock Trader's Almanac, the incumbent party loses the presidency if the Dow Jones blue-chip index falls more than 0.5 per cent in the final calendar month before polling day. The Dow fell by 0.52 per cent in October.

According to Jeffrey Hirsch, the editor of the almanac and president of the Hirsch Organisation, this gauge holds true for every poll for exactly 100 years.

However, the marginal outcome - of just 0.02 percentage points - on the Hirsch monitor may simply reflect the pollsters' views of Election 2004, which is forecast to be an even tighter outcome than 2000's bitter battle.

In fact, in the final trading week of October the Dow posted a 270-point rally - echoing the sudden flip in one poll that gave President George Bush a stonking 51 per cent share of the vote. Having started October on 10,080 it fell to 9,750 before climbing to 10,027 - just three points short of the 10,030 that would have marked a 0.50 per cent fall.

Overall, however, the polls were still showing that Mr Bush and his Democratic challenger, John Kerry, were virtually neck-and-neck going into the final day of campaigning yesterday.

With all to play for, markets have started to worry about the implications for stock, bond and currency markets going forwards. Perhaps the one thing most analysts can agree on is that a disputed outcome that takes days, weeks or even months for the law courts to declare a winner would be a nightmare scenario. According to a poll of traders by 4Cast, the London-based economic consultancy, a disputed outcome would trigger a massive sell-off across the US markets.

They predicted the dollar would slump 1.5 cents against the euro, the Dow Jones would suffer a 2 per cent fall on the first trading day after a disputed result although - surprisingly given their role as safe-haven investments - bond yields would be unaffected.

Alan Ruskin, its US research director, said these reactions would be much more extreme than in 2000 when both the dollar and the Dow Jones suffered modest falls. "Perhaps this is because in 2000 either party - the Democrat status quo or the Republicans - were seen as equity friendly," he said.

Tom Sowanick, the chief wealth management strategist at Merrill Lynch, said the dominant factors in 2000 were already in place at the time - a weakening economy, falling stock market and expected cuts in interest rates. "The most striking behaviour after the 2000 election is what did not happen," he said. "Stocks were declining before the election as the tech bubble unwound and showed no discernible reaction to the post-election uncertainties."

So what happens when the winner is declared either early tomorrow morning or several days later? Will it make much difference to have a Democrat rather than a Republican? As ever with the economists, the answer is yes and no. In historical terms Democrats have on average presided over larger stock market gains than Republicans. Since 1901 the Dow Jones has risen by 7.2 per cent a year when a Democrat occupies the White House, compared with 3.6 per cent for a Republican.

Interestingly, the largest gain is for a Democrat president with a Republican Congress - a likely outcome - when stocks rise by almost 10 per cent. "This combination appears to deliver the best legislation," Mr Hirsch said.

In addition, he said equities tended to suffer in the first two years of a presidency before bouncing back in the final 24 months. "The incumbent party will do whatever it needs to get re-elected and this applies to the fiscal and monetary stimulus that manufactured the 2003 bull market."

Other analysts believe that the fate of the stock market has already been decided by fundamental factors irrespective of who wins. David Schwartz, a stock market historian, said: "Over the last three centuries in every index in every country where the market has had a vast rally it always returns to its long-term trend line. There's never been an exception and the long-term trend for the Dow is currently around 5,000. There's two ways it can play out, with another sharp fall or a long drift sideways."

There are, of course, differences on policy between the two candidates that could have both macro- and micro-economic implications. Mr Bush is likely to seek to make his first-term tax cuts permanent while Mr Kerry would revoke the tax cuts for Americans earning more than $200,000 (£110,000) a year, which he says would affect 2 per cent of the population. According to SG Corporate and Investment Banking (SGCIB), Mr Bush's policy would cost $841bn over 10 years compared with $415bn under Kerry.

On the spending front, Mr Bush relies on curtailing spending in all areas except for defence and security while Mr Kerry is planning substantial increases on healthcare and education spending alongside a crackdown on the costs of buying drugs and services from the private sector.

Stephen Lewis, the chief economist at Monument Securities in London, said: "Equity markets seem uncertain about the implications of the election for stock values, except in such obvious ways as Mr Kerry being bad for pharmaceuticals and Mr Bush good for tobacco stocks."

The 4Cast poll shows traders expect a 1 per cent rise in the Dow the day after a Bush victory but a similar sized fall for a Kerry triumph. Mr Ruskin said: "The market is taking a traditional line where the Republican Party is perceived to be more 'pro business' and therefore positive for shareholders."

The greater impact may be on the dollar and Treasury bonds although here again any forecast is overshadowed by the wider economic problems that the new president will face. Stephen Gallagher, the chief US economist for SGCIB, said the US current account deficit was deteriorating rapidly and getting close to the 6.0 per cent of GDP level that would suggest "turmoil".

"The dollar will be determined by trade adjustments and interest rates, neither of which can be controlled by the president," he said. "The best outcome is a smooth trade deficit narrowing, which may require a softening dollar."

David Bloom, a global economist at HSBC, said: "Short-term uncertainty would be greater under Kerry because the market will be unsure what dollar policy will be as a Kerry victory would almost certainly mean a change in Treasury secretary."

Far more important will be the replacement for Alan Green-span, the chairman of the Federal Reserve, whose term expires in January 2006. Robert Rubin, the treasury secretary under Bill Clinton, is seen as the front-runner for the Democrats while Martin Feldstein, a Harvard professor, could get the nod from Mr Bush.

Whoever takes over, it will be the first change of Fed chairman in almost 20 years. Just as abortion campaigners see the nomination of new Supreme Court justices as the most important consequence of this election, so the markets should be worrying about Feldstein/Rubin rather than Bush/Kerry.