President Obama's victory last night signals two dominant investment themes for the rest of the year. First, markets will rapidly adjust to a probability that Federal Reserve Chairman Bernanke's low interest rate policies will continue for the foreseeable future. As that expectation becomes priced in, investors may expect higher fixed income prices going forward. If so, then over the very near term, traders will probably do well with funds such as ishares 20 year Treasury Fund (NYSEARCA:TLT). Initially, domestic stock markets will fall as traders flock to bonds, but once bond market pricing has adjusted, longer-term investors may start to move money into higher yielding risky assets, such as dividend stocks. If so, that could support pricing in funds such as ishares Dow Jones Dividend Select Fund (NYSEARCA:DVY) and SPDR S&P Dividend Fund (NYSEARCA:SDY) could do well going into the end of the year and possibly beyond. However, there are at least two other forces that may affect pricing in equities and equity funds, as described below.
Second, President Obama's victory will put the fiscal cliff issue front and center into the minds and plans of investors. This should play out in several ways. To begin with, longer-term investors may start to sell stocks and other assets that have significant built-in capital gains, hoping to lock in lower capital gains rates this year and avoiding potentially higher capital gains rates next year. If so, equity markets could experience significant selling pressure, especially in securities that have done very well over the past years. On a related note, uncertainty over future tax rules, the prospects of sharply reduced government spending, and ongoing acrimony and failures to comprise between the House Republicans and the Senate and White House will pressure equity prices simply because markets detest uncertainty, giving sellers an edge over buyers.
However, equity prices may find some support if companies decide to pay special dividends this year, locking in lower dividend tax rates for their shareholders this year, as opposed to potentially higher dividend tax rates next year. If so, income investors may flock to dividend paying stocks, which will offer yields substantially higher than yields in lower risk fixed income assets.
Stepping back, though, President Obama's victory is probably less relevant to equities prices than other factors, such as corporate earnings. From a political, monetary and fiscal standpoint, voters have delivered the capital markets the gift of "more of the same." Overall, equities markets have put in a fairly solid performance over the past for years, despite the negative headlines. All things being equal, what President Obama's victory signifies is probably nothing more than an increased likelihood that markets will be turbulent going into year end, investors will be shuffling some assets, and that companies will be deploying corporate cash reserves into share buybacks and special dividends. There will be dire headlines, and stock prices will potentially drop by a fair amount - at least until the Congress and White House finally do address the fiscal cliff issues (either at the 11th hour on December 31st, or in the later part of January). Investors who are willing to hold their noses and buy stocks while prices drop could have some great opportunities coming up in the coming weeks and months, but ultimately, the political drama will pass and markets will go back to confronting fundamental issues such as corporate earnings growth, record low interest rates, improvement in the housing sector, and the like.
Disclaimer: I am not a registered investment advisor, and no reader may rely on any statements in this article as investment advice or as a recommendation of any particular security or course of investment action.