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updated 12:00 a.m. ET Oct. 27, 2008

BusinessWeek

Five Myths About the Election and the Stock Market

With the Obama-McCain contest nearing the finish line, BusinessWeek debunks some Wall Street notions about bulls, bears, elephants, and donkeys By Ben Steverman

Business Week

For the first time in 76 years, a financial crisis is occurring at the same time as a Presidential election. Based on recent polls, the coincidence seems to have boosted the chances that Illinois Senator Barack Obama, the Democratic nominee, will defeat Republican Arizona Senator John McCain on Nov. 4. The financial crisis has affected the Presidential race, but how is the election affecting the financial markets? Pundits offer endless theories on that question, and their answers are often suspiciously similar to their political views. Thus, right-leaning market experts insist Obama's tax proposals would be disastrous for investors. More liberal Obama supporters insist the market will celebrate if he is given the job of leading the world out of the financial crisis. Some of these claims are impossible to prove or disprove. But there are some myths about the election and the stock market that need clearing up. Myth No. 1: The stock market is waiting to see who wins. Stock traders are used to looking at the data, weighing probabilities and making investing bets based on them. Among fund managers, analysts, and other market professionals interviewed in the past week, there is little doubt which is the more likely outcome of the 2008 Presidential election. Consider two pieces of evidence the "smart money" on Wall Street would be likely to take seriously: On the Iowa Electronics Market, traders can put up money to make bets on the outcome of the Presidential race. On Oct. 3, Obama was given a 70% chance of winning. On Oct. 23, it was 87%. Then there are the polls. Nate Silver, who first achieved renown in the area of baseball statistics, runs a sophisticated daily analysis of all polling data that incorporates state-by-state demographic factors, historical data and polling firms' past track records. On Oct. 23, Silver's

site, www.fivethirtyeight.com, rated Obama's victory a 93.5% likelihood. That's not to say that McCain can't win the election. [Google the name "Thomas E. Dewey" when you have a spare moment.] He still has a chance, but based on the forecasts the Street is watching, the probability of a win is so small that very few investors are going to bet money on a McCain victory. Myth No. 2: Wall Street is disappointed at Obama's lead in the polls, because it always wants the Republican to win. There is anecdotal evidence that investors in some sectors are worried about an Obama victory. With Democrats in control, Washington could squeeze profits for health-care firms or energy companies, for example. And it's true that it's not hard to find a Republican on Wall Street: Wealthy investors and financial professionals tend to favor low taxes and deregulation, planks of the Republican party platform. However, Obama has plenty of supporters among investors, too. Berkshire Hathaway (BRKA) Chief Executive Warren Buffett is an Obama supporter, and many hedge fund managers and others have contributed to his campaign. In fact, according to the Center for Responsive Politics, donors in the securities and investment industry have given $11.1 million to Obama's campaign, and only $7.7 million so far to McCain. A 2004 academic study [by Scott Beyer, Gerald Jensen, and Robert Johnson] found that, from 1926 to 2000, the broad Standard & Poor's 500-stock index actually performed better under Democrats than Republicans, 15.24% vs. 10.78%. However, that Democratic advantage evaporated when the impact of the Federal Reserve -- which sets interest rates -- was taken into account. Myth No. 3: Investors and traders are watching the election closely, following the candidates' proposals and rhetoric. "Truly I don't think the market is paying much attention," says John Merrill, chief investment officer of Tanglewood Wealth Management, when asked about the election. "Today the market and the economy are shaping events much more than the Presidential election." It's not that the Presidential election doesn't matter to investors. It's just that other events -particularly the financial crisis and the economic slowdown -- have taken center stage. "We have so many other things on the table right now that we haven't even thought about the election," says Greg Church, president of Church Capital Management.

Wall Street often shows a healthy skepticism to candidates' rhetoric and party platforms. American history is full of examples of politicians who abandon campaign promises once in office. McCain, if victorious, would have trouble getting his proposals through a Democratic Congress, observers say. And both candidates would need to adjust their policies to the realities of the financial crisis and recession. What matters is "less who is elected than what policies they pursue," says Andy Bischel, president of SKBA Capital Management and comanager of the AHA Socially Responsible Equity Fund (AHSRX). Myth No. 4: The market is alarmed by prospects the capital-gains tax rate could be raised. Earlier this year, some were worried about a stock market sell-off if Obama was elected, due to his proposal to raise taxes on capital gains for wealthy investors. The theory was that investors would rush to sell stocks before the higher tax rate took effect. Though higher taxes can be a burden on the economy, this theory of a short-term impact from Obama's tax plans was always open to question. "You try not to let tax implications dictate [investment] decisions," says financial planner Micah Porter of Minerva Planning in Atlanta. As stock prices plunged the last two months, those worries have mostly evaporated. The S&P 500 closed at 908.11 on Oct. 23. In the last 10 years, the market has traded above this mark for all but a brief period, from July 2002 to April 2003. If you bought stocks at any other time, there's a good chance you have no capital gains to be taxed. Myth No. 5: Wealthy investors can breathe easier because the next President wouldn't dare raise income taxes in a recession. Investors don't like paying taxes, so Obama's proposals to raise taxes on the wealthy are a frequent subject of conversation among market professionals. Economists and Washington observers, however, see few prospects to avoid higher taxes -- even if McCain is elected. One reason is the federal government's bailout plan, which adds $700 billion or so to an already bloated federal budget deficit. Even before the crisis hit, President George W. Bush and a Republican Congress had been unable to extend Bush's tax cuts beyond their scheduled expiration in 2010. While higher taxes can hurt, a huge budget deficit is "really a problem in the long run," says Victor Li, an economics professor at the Villanova School of Business. "Whoever wins, the revenues have to be raised somewhere. Taxes have to be raised." Many hope that Obama -- or McCain, cutting a deal with a Democratic Congress -- can delay this tax-raising until the economy revives. Obama "needs to be really realistic about raising taxes in an economic environment that could be really nasty," Church says.

"Right now, the focus of the Democrats is on stimulating the economy," says Daniel Clifton of Strategas Research Partners. However, a tax increase during a recession wouldn't be unusual, he adds. "Generally the government has to raise taxes in a recession because the federal deficit gets so big." Join a debate about whether Election Day should be a paid holiday. Copyright © 2008 The McGraw-Hill Companies Inc. All rights reserved.

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