What does the Obama victory mean for investors?

By Bob Doll
Vice Chairman and Director of BlackRock^®
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As President-elect Barack Obama and his supporters celebrate his election victory over Senator John McCain, investors around the world are wondering how an Obama administration will impact the U.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 tricky business. Despite all of the prognostications and financial analyses that are a part of the process, at the end of the day, we believe the market impact of the election will be less than most observers think. Like all elected officials, President Obama will focus on only a fraction of the initiatives he discussed on the campaign trail. Additionally, exogenous events and surprises inevitably come up, many of which have greater bearing than politics on the markets. In the current environment, this is perhaps even truer than ever. The economy is deeply troubled, markets have been thrown into turmoil and government action has been unprecedented recently. In this sort of environment, discussions about how President Obama’s energy plans might impact the energy industry, for example, are taking a back seat to the broader issues of the credit crisis and economic recession. With these caveats in mind, we can make some observations based on President-elect Obama’s positions and can forecast some possible consequences.

From a political perspective, it is important to remember that any campaign promises made 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 large a role as the presidential election in determining how markets react. From the election results that are now in, the Democrats have picked up several seats in the Senate, although, from this vantage point, it appears they may be just shy of the 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 Representatives, further increasing their advantage there. While these majorities (and Mr. Obama's convincing margin of victory) should make it easier for President Obama to get his legislation passed, Democrats will not all move in lockstep on every issue and the Republican Party will no doubt be able to continue exerting at least 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 which voters were focused. In fact, most pundits believe this focus was one of the main factors 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 the new Obama administration, and it will make it more difficult for him (and the new Congress) to enact some of the wholesale changes he has been discussing. Simply put, there probably will not be enough money available to enact every new program Mr. Obama has been proposing. As an example, we would point to Mr. Obama’s ambitious healthcare program, which would provide low-income Americans with subsidies to purchase health insurance. Such a plan would require significant tax incentives and/or spending increases, and while it would not be surprising to see some sort of change in the way health insurance functions, the realities of the federal budget will force the new administration to amend some of its plans. From aninvestment perspective, this again means that proposed healthcare changes are unlikely 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 scale of government intervention that has come about over the past couple of months (including the recapitalization of the banking system, nationalizing financial institutions, insuring deposits and the government’s purchase of equity stakes in the 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 creation of all of these new programs from the executive branch, rather than inherit them as he assumes office. While Mr. Obama is on record as being largely in agreement with the changes that have occurred, had the economic situation not been so dire, he surely would have preferred the opportunity to shape these plans himself. In any case, he will most likely have the chance to put his own mark on fiscal stimulus measures. There have already been discussions in Congress about the possibility of creating a new fiscal stimulus plan. The outlines of such a plan are only beginning to fall into place, but such a plan could potentially include an extension of jobless benefits, investments in infrastructure projects, a moratorium on foreclosures and extended or new tax credits for individuals or corporations. It is also likely that some additional legislation focused on limiting the short-term risks to home prices will be enacted. At present, the timing and scope of such a plan remains highly uncertain, but we would not be surprised if the government delays action until Mr. Obama and the new Congress take their seats in January.

What Is the Tax Outlook?

The economic issue of primary concern to most investors is what will happen on the tax front. With the economy in recession, we think it is a foregone conclusion that the government will be forced to borrow more money and to increase tax rates simply 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. There will be little appetite for significantly raising taxes when times are so difficult for many Americans. As such, we would be surprised to see significant tax increases enacted in 2009.

Tax policies have been a centerpiece of Mr. Obama’s campaign and his plans (if enacted) would have an impact on investors. Mr. Obama has been pushing for higher marginal tax rates for individuals in the highest tax brackets and reductions for those in the lowest. Furthermore, he has proposed taxing “carried interest” from hedge funds and private equity investments at marginal income tax rates. We do believe that overall tax levels will climb over the next four years, specifically for higher-income Americans.

Another tax issue weighing on investors’ minds is the outlook for continuing the favorable tax treatment of long-term capital gains and qualifying dividends (the 15% tax rate currently is set to expire in 2010). Mr. Obama has indicated that he plans to eliminate this favorable tax treatment (although he has stated that dividend income for lower-income Americans would not be affected). It seems quite likely that under an Obama administration, dividend income and capital gains tax rates will increase for many, if not most, investors. By this measure, then, we think higher tax rates for investors will be a headwind for equities (albeit not an insurmountable one) in the years ahead.

We would point out, however, that while the likelihood of higher tax rates is a negative for some investments, municipals are one of the few areas of the market likely to benefit from increased taxation. As tax obligations increase, the tax-exempt nature of municipal bonds becomes more attractive to a wider audience. This, in turn, 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 that were a hallmark of both the Clinton and Bush administrations, Mr. Obama tends to focus more heavily on protecting U.S. industries, and on environmental issues and labor rights, when considering trade issues. Mr. Obama voted against the Central American Free Trade Agreement (CAFTA) and during the election season questioned 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, from an equity perspective, Mr. Obama’s potential trade policies may benefit traditional American manufacturing industries, but we would also point out that protectionist policies are, on balance, equity-negative, run the risk of slowing overall economic growth and can add to inflation concerns via wage pressures.

What Will the Overall Effects of the Election Be on the Equity Markets?

With the important caveat that earnings valuations and other fundamentals will have a much greater impact on markets than will legislative decisions, we do believe that the actions of Congress and President Obama might affect the market in various ways that could have implications for equity portfolio positioning.

From a historical perspective, we would first point out that equity markets tend to underperform when Congress and the White House are occupied by the same political party and tend to experience better performance during times of “divided government” (with the most recent and strongest example occurring during the 1990s when President Clinton faced a hostile Republican Congress). This is hardly an insurmountable obstacle, but, if history is any guide, it could represent a minor headwind for equities for at least the next two to four years.

Within the context of equity sectors, there are some additional observations we can offer. On the energy front, the Obama administration will likely be more “green friendly” than we have seen in the past, and will focus more heavily on climate change and global warming. While this could be a negative for traditional energy companies, his plans could benefit alternative energy companies. Regarding healthcare, universal healthcare has been a key pillar of Mr. Obama’s campaign. It is difficult to predict exactly what impact his plans might have, but there is a general sense that managed care companies would face increased costs under his initiatives.

As we indicated earlier, Mr. Obama’s views on trade could benefit some traditional manufacturing companies, but also run the risk of being a net negative for equity markets. Additionally, his focus on infrastructure improvements could be a boon for construction-related companies.

In closing, we would also point out that the “uncertainty effect” surrounding politics has finally been removed (at least for now). Since the 2006 mid-term elections, there has been intense focus on this election and, as a rule, markets loathe uncertainty. At the least, the uncertainty over the election outcome has been removed from the list of negatives impacting the markets.

Bob Doll is a Vice Chairman and Director of BlackRock®, a premier provider of global investment management, risk management and advisory services. Mr. Doll also is the Global Chief Investment Officer of Equities, a member of the BlackRock Executive Committee and holds a seat on the BlackRock Board of Directors. Additionally, he is lead portfolio manager of BlackRock’s Large Cap Series Funds. Prior to joining BlackRock, Mr. Doll was President and Chief Investment Officer of Merrill Lynch Investment Managers.