It's clear that, in addition to Obama's significant victory at the polls, Democrats will widen their majorities in both houses of Congress (however, it seems unlikely that the Republicans will lose the filibuster in the Senate). This is likely to have some significance in terms of tax and trade, and massive implications for foreign policy. Of particular concern is the expansion of entitlement spending, the status of trade agreements and expected increases in capital gains and income taxes.
For several reasons, I suspect that the scope of reforms under the new government will be considerably more limited than most supporters hope and many detractors fear. This is due to a lack of ideological consensus in the Democratic party, limited government resources and the difficulty of engineering substantial changes, at least in the short run. In particular, I doubt that much progress will be made on entitlement expansions or the reform of existing trade agreements. I do, however, expect that taxes on capital gains and ordinary income will increase starting in 2010.
Firstly, Democrats have gained power by endorsing candidates that are considerably more conservative (particularly on social issues) than the party's traditional platform. These "Blue Dog Democrats" tend to be somewhat more populist than Republicans, but are generally more reflective of the American mainstream on budgetary issues and entitlements. Abandoning fiscal conservatism was as much as anything what lost the Republicans power, and this is something that many Democrats (if not the Democrats) understand. While the current financial crisis has raised substantial concerns among the electorate and increased support for yet another stimulus package, the public's support for balanced budgets and budgetary restraint is unlikely to go away soon. Their enthusiasm for health care reform is limited to the extent that their standard of care isn't adversely effected.
Surveys show that the vast majority of Americans are reluctant to tolerate any reforms that would reduce the standard of care they receive in terms of health care. By and large, they find the health care they receive to be expensive, but of high quality. It is difficult to understand how patient care quality cannot go down on average if the aggregate cost and standards remain the same, while adding some numbers of people to the system. The open secret of anti-poverty initiatives is the understanding that poverty is reduced through redistribution of income and that fundamentally, the median standard of living must decline in order to alleviate poverty. This has never been particularly popular with voting Americans, and what I suspect we'll see is a repeat of the 1993 debacle, if anything, on this issue.
Congressional Democrats and the Obama Administration are also likely to feel severely constrained in the creation of entitlement programs, at least in the near term. Instead, the focus is likely to be on preserving Medicare in the coming years, as the budgetary crisis is likely to intensify in the program as it approaches bankruptcy in the 2015-2020 period. Obama has been (and is) considerably vague on his proposals in this area, reflecting his own realization that the problem is far more politically complex than many appreciate. Thus, I suspect that changes in health care are likely to be incremental - particularly over the next few years. with a focus on seeking out the low hanging fruit of technological innovation.
Obama has sent conflicting messages on free trade; there is a particular disconnect between his writings in The Audacity of Hope and much of what he's stated on the campaign trail. There appears to be a fundamental disconnect between Obama and his advisors as well on numerous issues related to NAFTA and the advantages of trade. This has inspired many of his more conservative supporters to predict he will back track on his trade rhetoric after the election. Regardless of his views on the subject, it seems unlikely that the new administration will be able to (at least unilaterally) renegotiate important trade agreements, as entrenched interests exist to maintain the existing trade regime. However, expansion seems similarly unlikely, as the mood of Congress, and of foreign governments, is generally unlikely to favor new trade agreements in the near future. Expect a great deal of thunder on this issue, but little real progress (or damage).
Due to the sunset provision in the 2001 tax legislation passed by a Republican congress, it seems likely that taxes will increase to pre-2001 levels in 2010. In particular, one should likely expect increases in the rate of taxation of dividends, capital gains and ordinary income. It is difficult to imagine how the budget deficit can be brought to manageable levels (let alone eliminated) without increases in taxes. It's safe to assume that any tax increases will be highly unpopular (and likely ineffective) if they come before 2010, and its reasonable to expect that allowing the tax reductions of 2001 to expire will be an attractive alternative to the Congressional leadership. that having been said, there will likely be efforts to simultaneously reduce taxation in certain areas (particularly capital gains on venture capital) while increasing it in others (ordinary income on high incomes). Call 2008 a good year for CPAs and you wouldn't be too far off.
If there is one area of the federal government budget that is likely to suffer, it will be defense. The intellectual heritage of the post-Vietnam Democratic party, the inherit ambivalence of the American public to the current wars and a general feeling that foreign policy is a lower priority is likely to mean that regardless of what military leaders say they require, the focus will be on a "smaller, more efficient" (i.e. cheaper) military. An emphasis on air power, conventional strategic weapons and surveillance technologies are likely to prevail, but overall, budgets will decline. Whether this reduction in "hard power" will be compensated by the increased "soft power" of an internationally popular President is a very complex question that I will leave to the political scientists. But, regardless, less money will be spent on soldiers, weapons systems and general military expenditures.
What this all leads me to conclude is that growth companies (ones that are less likely to rely on debt financing and pay dividends) are likely to outperform value stocks. Bond markets are likely to be more volatile, at least in the short term, leading one to favor more aggressive bonds and ones with shorter maturities, as the fixed income markets determine whether budget deficits are likely to remain large and taxes high, leading investors to demand larger yields to compensate for lower after-tax returns and higher risks of default.
As a Democrat, I am more inclined to view the outcome of the election positively. However, I do remain concerned that increased entitlement spending and (significantly) higher taxes (particularly on capital gains) will retard economic growth and that will result in lower returns for most investments. Of particular interest to me in the short term is to see how the Obama agenda begins to develop in response to what are likely to be increasingly depressing economic news over the next two or three weeks. A continuation of the populist "spread the wealth around" rhetoric that became prominent in the election would certainly cause me to temper that view. In the coming days, it will be important that our new president reassure investors that the first priority of his administration is the health of the private businesses that make up the economy, not abstract (and highly subjective) notions of social justice.
That having been said, investment values are primarily determined by investors' expectations of the future. The current leadership's low popularity has undoubtedly played a substantial role in exacerbating the effects of the recent financial crisis. Regardless of your political affiliation, there are substantial reasons to believe that the national mood (and thus stock market values) is likely to be enhanced by a new, young and (at least, currently) popular leader.
