Seeking Alpha
Small-cap, long/short equity, special situations
Profile| Send Message|
( followers)  
Some have viewed the inability of Congress to produce any meaningful legislation in recent terms as a consequence of the scant majority Republicans held in either the House or the Senate. Yet there is widespread optimism that with Democrats taking over this term, that there will be reforms galore along several fronts from health care to energy to corporate reporting. The fact that the Democrat majority is even weaker than that previously held by the Republicans appears to have eluded some.

In the Senate, the majority is resting on the shoulders of a man currently in physical and speech therapy. I hope the Democrats are not counting on Senator Johnson for any filibuster tactics!

Legislative Lay-up

This new-found confidence in Congress can be seen running through our coverage universe. For example, after a couple of earnings surprises, Fuel-Tech, Inc. (NASDAQ:FTEK) has become something of a Wall Street darling in recent months. Fuel Tech develops and sells air pollution abatement systems for combustion boilers, which are popular with coal-fired power plants in particular. Earnings surprises in the last few quarters and a busy road-show schedule for Fuel Tech’s management have been key drivers for the stock price.

Nonetheless, part of what may be encouraging investors is the change in leadership on Capital Hill that is expected to favor environmental protection. Senator Barbara Boxer takes over the Senate Environmental Committee in what many expect to be a sea-change for environmental policy coming out of Washington. She replaces Jim Inhofe, a Republican senator from Oklahoma, who has been an outspoken skeptic of global warming theories. Boxer, on the other hand, has made climate change a top priority. That topic alone could keep the Committee busy for the entire term.

Companies like Fuel-Tech are expected to flourish if legislation puts more pressure on air polluting power plants to reduce emissions. Power plants are a significant source of air pollution and would seem a likely target for politicians looking to make changes. Coal-fired power plants are responsible for nearly 60% of the sulfur dioxide, 18% of nitrous oxides and about 50% of the particle pollution in the U.S. skies. In addition, coal-fired power plants are the largest polluter of toxic mercury. The oldest plants are the dirtiest because they were grandfathered into the Clean Air Act passed in the late 1970s and have not had to meet pollution control standards. The thinking at the time was that these plants would be taken off line and therefore would never be a problem. Yet today most power plants are 30 to 50 years old and these are as much as ten times dirtier than the new plants.

Even if the new Congress, highly populated with environmentally conscientious Democrats, were to pass new legislation that would require these old plants to clean up, it is far from a given that this will lead to a dramatic increase in demand for air pollution abatement solutions. The economics of pollution abatement could probably drive the last nail in the coffin of these plants and they might finally be taken off line rather than outfitted with solutions like Fuel-Tech’s NOxOUT product as an example. Accordingly, we are maintaining a cautious view on Congressional action as a growth driver.

In the meantime, Fuel-Tech is finding plenty of low hanging fruit in the U.S. even without new Congressional action. The need to clean up the air for the fast-approaching Summer 2008 Olympics also has China’s power plants clamoring for Fuel-Tech’s NOxOUT Ultra solution. Senator Boxer has also promised increased money for the Superfund program, a move which should accelerate and expand projects for hazardous waste cleanup, as well as action on standards for perchlorate contamination in drinking water.

While developments along these lines could benefit other names in our coverage universe - American Ecology, Inc. (NASDAQ:ECOL) provides hazardous waste disposal services and Basin Water, Inc. (BWTR) providers ground water treatment systems - we recognize it is a matter of timing when these company’s could see a meaningful increase in their top-lines.

Political Gains

The unanswered question is whether an enthusiastic majority on both sides of Capital Hill is enough to make up for the fact that a member of the minority party is sitting in the Oval Office. In my view, the real test for this Congress is yet to come. Congress has demonstrated little leadership strength in recent years. Democrats need to demonstrate their ability to craft and pass legislation that will get signed by the Republican president. Otherwise, it is just politics as usual. Accordingly, we believe it is a b,it too early to call a “legislative lay-up” for our coverage universe.

The changes in leadership on Capital Hill have dominated the press and media in the last three months. Unlike many on Wall Street, I am a bit skeptical of what the Democrats are capable of accomplishing. We are taking a cautious approach with regard to the impact Congressional action could have on the fortunes of companies in our coverage universe. Part of our caution comes from a rather jaundiced view on Congress in general, regardless of which party is in control of the votes. Capital Hill appears rife with partisanship and nest-lining at the expense of real reforms that benefit citizens. It is also a bit perplexing how the Democrat Majority is more likely to make things happen now than when the Republicans held the most seats. Republicans got nothing done after six years with control of both legislative branches complemented by a man of their own party in the Oval Office.

Such a state of political harmony is theoretically the most conducive to substantive action. (The war in Iraq does not qualify as an example of Congressional action as Democrats and Republicans alike were more or less bullied by Bush’s hegemony.) In my view, this whole idea of Congressional control is overrated as a portent force in…well, just about anything and especially stock returns.

This runs against popular thinking, which holds that equity market performance is better when the presidency, the House and Senate are not controlled by the same party. The logic is that when less legislation gets passed and signed into law, business benefits. An article entitled “Gridlock’s Gone, Now What?” appearing in the September 2006 issue of the Financial Analysts Journal describes the work of two professors, Scott Beyer of the University of Wisconsin Oshkosh and Gerald Jensen of Northern Illinois University, and Robert Johnson of the CFA Institute. Their article was written before the November 2006 elections, but the work provides valuable insight into Congressional politics, economic conditions and the stock market. After examining long-term security returns relative to shifts in the political landscape over the fifty years between 1954 and 2004, the trio found that the popular view “gridlock is good” for equity securities is largely a myth.

During the fifty years in the study, equity returns, especially to small caps, tended to be higher and less volatile during periods of political harmony. This suggests that Wall Street should be concerned, not encouraged, with the Democrats taking over while a Republican is still ensconced in the White House. Worse yet, for those focused on small-caps, small-cap returns tend to lag large-caps during periods when party control of the House, Senate and Oval Office were mixed.

Disclosure: Author has no position in the above-mentioned stocks.

Source: Can a Congressional Democratic Majority Solve Global Warming? Probably Not