What Mitt Might Mean For Stocks

Includes: DIA, IVV, QQQ, SPY, VTI
by: Viking2010

At this point, it appears likely that Mitt Romney will win the Republican nomination for President (his recent win in Iowa will go a ways towards sealing the deal) and quite possible that he will be elected president of the United States. So what will this self-described "conservative businessman" be able to do for the sputtering American economy, and (more importantly from an investing standpoint) what impact can he have on domestic stocks? To find out, I delved into his jobs plan (compiled with help from star economists Glen Hubbard and Greg Mankiw), paying attention to how the proposed policies will impact equity markets in the U.S. Here is what I found:

Most obviously, Mitt Romney touts that he will be a self-described "pro-business president," a notion doubtlessly connected to his correct assertion that "companies are people too." Romney makes it abundantly clear in his stump speech and on his website that he understands the intimate connection between the success of American companies and the prosperity of the American people. There are few overt indications that President Obama doesn't understand this connection, of course, but the harsh reality is that many business leaders feel that he has thrown them under the bus and their feelings matter because it is up to them to invest in the United States and truly spark an economic recovery. With his reliably pro-business rhetoric and refusal to villainize CEOs and bankers, Mitt can make the people who matter feel better about themselves and their occupations, and while that effect is abstract and ambiguous in magnitude I feel it could be one of the strongest positive benefits to stocks of a Romney presidency.

One prominent and oft-talked about portion of Romney's plan is to eliminate taxes on capital gains, dividends and interest rates for those earning less than $200,000 per year. There are two immediate effects of this change. The tax burden of those taxpayers will be lessened (an income effect) allowing them to spend more on goods and services, stimulating the economy (assuming government spending stays constant). There will also be a substitution effect as consumers choose to save more of their money for the future now that such action isn't taxed. This has the potential to decrease current spending somewhat, leaving the change's effect on net spending ambiguous, but both effects increase the amount taxpayers would place into stocks, bonds, and banks.

The economic effects of this are difficult to explain but probably very positive (investment increases productivity and living standards in the long run), but the effect on the stock market is quite clear. More money chasing stocks means higher stock prices, but that is far from the only effect. The expectation of a capital gains tax cut provides a large incentive NOT to sell stocks especially if an investor is in the green on his/her investment, as said person would be inclined to wait in hopes of avoiding paying taxes on the investment. The overall effect of such a cut is unambiguous: higher stock prices, both short and long-term.

Another tax-cut Romney is proposing is much simpler to analyze. He would cut the top corporate tax rate from 35% to 25%. Now, few if any companies pay the full top rate, but decreasing it will still save companies money and encourage economic organization and efficiency. Coincidentally, it will make companies more profitable, giving them more money to return to investors and raising share prices for domestic stocks in the long-run.

Turning to trade, Romney has two main objectives: aggressively pursuing free-trade agreements and ensuring China plays fair. Free-trade has been accused of being anathema to American business as they have struggled to compete against cheap labor and efficient business practices in the past, but as I wrote recently I feel American manufacturing is actually poised to outperform and that such agreements will likely be positive for the American economy, and thus our stocks as a whole. As far as cracking down on China, unilateral punitive measures (or the trade war which could easily follow) would tend to hurt American consumers but help businesses, especially domestic manufacturing. If China does not respond, then I would expect the effect on stocks to be positive. A brutal trade war is harder to predict about, but I think that any punitive measures are unlikely. The yuan has quietly strengthened a great deal, and by the time Romney gets to the White House there may well be no reason for such punitive measures.

Another area where Romney has been eager to get to work is regulation. Most regulations exist as a way for government to internalize the externalities business practices have on other business and the public. Both Dodd-Frank (finance reform) and the new mercury regulations fit into this mold, for example, as do various climate-change related regulations that Obama supports, likely to be among Romney's top targets for elimination. It seems the general effect of the standard call for less regulation is to increase current economic production and growth at the expense of costs to consumers associated with that growth (cancer from mercury, for example). Thus, rolling back regulations should increase both economic growth and corporate profitability by lowering the various costs of compliance, making such action a positive catalyst for domestic stocks (though not necessarily public health), especially in the short to medium term.

By far the most difficult element of Mitt's plan to analyze is his call for lower federal spending. On the face of it, cutting spending could take the recovery out at the knees, something liberal economists like Paul Krugman are already bemoaning. On the other hand, the specter of a European style meltdown is always present, and though the fact that the United States has its own currency is helpful, no one wants to see America become Japan either... there is simply no good end to an upward spiral of debt. The result of Mitt's plan is likely somewhere in between the two camps, but the safest bet is that in that less spending now hurts stocks modestly in the short run by weakening the economy but is good in the long run as tax rates stay lower and the potential for crisis is mitigated.

Overall, then, I expect a Romney presidency to be modestly positive for the stock market, reflecting largely Romney's belief in the power of business being applied across the policy spectrum. So long as Mitt is able to enact a good portion of his proposals and near-term spending cuts don't crush the economy, corporate America (and its equity) should do extremely well with Mitt in charge. As the odds of a Romney presidency increase, U.S. stocks look better and better.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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