SCENARIOS-Democratic upset may sink stocks; gridlock a worry

By Ryan Vlastelica

NEW YORK, Oct 20 (BestGrowthStock) – With investors looking for the
Nov. 2 mid-term U.S. elections to result in a split
legislature, an unexpectedly strong showing by either Democrats
or Republicans could spark a big move in stocks.

Republicans are widely expected to regain control of the
House of Representatives while the Democrats maintain a Senate
majority, though a Republican sweep is possible.

The unlikely scenario of Democrats keeping control of both
houses could spark a stock sell-off. However, some question
whether gridlock would be good for markets in the long term.

Below, three outcomes and their possible impact on stocks:
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ TAKE A LOOK Midterm elections & Wall St [ID:nN12177354] TAKE A LOOK On elections [ID:nUSVOTE]

Graphic showing Wall St poll results

http://link.reuters.com/fyd28p

Graphic on markets and midterm elections

http://link.reuters.com/jyz97p

Top News-U.S. elections

http://link.reuters.com/fyq86p

Reuters Insider show on Wall St wanting tax cuts

http://link.reuters.com/tev97p
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REPUBLICANS GAIN ONE HOUSE

Analysts say a split legislature has been priced in, and
few see it sparking a dramatic move. Several suggested that a
“buy the rumor, sell the news” down day was possible on Nov. 3,
but the overall reaction is expected to be muted.

For an analysis on this scenario, see [ID:nN11107575]

Jerry Webman, the senior investment officer at
OppenheimerFunds in New York, said because the gridlock outcome
is expected, Webman said, “the immediate impact on markets is
probably negligible.”

Options markets are currently priced for little in the way
of near-term volatility, but they expect volatility to rise in
the first few months of 2011.

REPUBLICANS TAKE CONTROL OF BOTH HOUSES

An unexpected victory in both chambers would increase the
Republican Party’s ability to shape or block legislation, and
analysts say this would be a near-term positive for markets.

“Republicans taking the House has been priced in, but if
there’s a surprise and they take both houses, that’s something
that hasn’t been priced in and the market will go higher on
it,” said Steve East, chief economist at Height Analytics in
Washington, D.C.

Market’s dynamics may also come into play. Investors who
sat out the September rally have been playing catch-up. Hedge
funds accumulating stock positions could buy more, according to
Schaeffer’s Investment Research in Cincinnati, Ohio.

With the S&P 500 (.SPX: ) currently around 1,170, a
Republican sweep would create “an initial celebration that
could take us up to our April high on the S&P around 1,220,”
said Elliot Spar, market strategist at Stifel Nicolaus & Co in
Shrewsbury, New Jersey,”

Spar said after the initial rally, he would expect markets
to resume focus on market fundamentals. The U.S. Federal
Reserve also meets that week, where they are expected to
announce a plan to pump more money into the economy, a factor
that could even outweigh the election.

DEMOCRATS MAINTAIN CONTROL OF BOTH HOUSES

In what is considered the least likely scenario, Democrats
retaining control of both chambers could hit sink equities,
even if their majority is eroded.

According to a recent Reuters poll of 53 analysts, 70
percent of respondents expect stocks to fall modestly or
sharply if the Democrats hold both houses. [ID:nN11142851]

Bruce McCain, chief investment strategist at Key Private
Bank in Cleveland, Ohio, said it was possible the S&P could
fall more than 12 percent, retracing a rally that started in
late June. “That range is still operative … but it would take
a significant disappointment to happen,” McCain said.

Coming deadlines for redemption requests from hedge funds
and the looming calendar year-end for many mutual funds at the
end of November could accelerate a selloff.

GRIDLOCK MAY BE HEADWIND IN LONGER-TERM

While many wish for gridlock, sluggish economic growth
could rekindle the clamor for government action.

Some worry that gridlock on market-sensitive issues such as
taxes and employment could stymie the recovery in the
longer-term and fan a selloff.

“I don’t view gridlock as necessarily good,” said Barry
Knapp, managing director of equity research at Barclays Capital
in New York. “As you get into 2011 and Congress starts dealing
with spending and deficits, gridlock will make it difficult to
cut spending and markets could (then) take a more cautious view
of what the implications of gridlock are.”

Michael Pento, the senior economist at Euro Pacific Capital
in New York, said markets could take a dim view of gridlock if
it freezes activity in Washington.

“Gridlock is nice if you’re stuck in a nice place, but it’s
bad if you’re stuck in a bad place. We’re in a bad place.”
(Editing by Neil Stempleman)

SCENARIOS-Democratic upset may sink stocks; gridlock a worry