How To Position For President Obama's Second Term

Includes: LMT, NOC, RTN, XLV
by: Alan Brochstein, CFA

Now that the conventions have come and gone, it's looking very likely that President Obama will have another four years in the White House. It takes a lot apparently to unseat a sitting president. After all, we re-elected Bush after barely electing him the first time. The polls are close, but the betting line heavily favors Obama. In case you aren't familiar with the real money trading site, Intrade, it has the odds at 57% in favor or a second term. Volume has accelerated dramatically in the past couple of weeks, adding some credibility to the prediction.

In the chart below, the blue line (and right scale) shows the odds of Obama winning reelection. I overlaid the S&P 500 (in red and scaled to the left), and there is a very strong correlation between the direction of the market and the odds of Obama winning:

(Click to enlarge)

This is usually the time of year when I start to think about the next calendar year with a bit more rigor. Last year, all of the chaos led me to delay my 2012 forecast until the end of October, but I expect to share my 2013 outlook in early October this year. Of course, anything can happen in two months, and Intrade could be wrong, but it seems like this is a good time as I begin thinking about next year to factor in a second term.

Obama's potential reelection is likely to be positive for stocks and negative for bonds. While I have less confidence in this assertion, I think that it bodes well for gold and energy prices too. Finally, I expect his second term could benefit certain sectors of the market, like construction companies,MLPs and healthcare and could be negative for defense-related companies.

One of the big myths when it comes to investing is that a Democrat president is somehow a negative, while a Republican is positive. In reality, the direction of the market is impacted by so many more things than who is President. Recent history would say that the exact opposite of common belief is the reality, as stocks soared during Clinton's two terms, stagnated during Bush's two terms and soared in Obama's first term.

My argument is based less on historical relationships than on how the two candidates would address the fiscal challenges we face. Romney, in my view, would be more aggressive on spending cuts, which would serve as an economic headwind in the near-term. More importantly, new presidents tend to take corrective actions early in their terms so as to boost their likelihood of reelection. Think back to Reagan or even Bush II. Both presidents had pretty rotten stock markets early in their terms. Of course, there are so few historical data points that it's impossible to have a definitive conclusion here based on history, but I think Obama is more likely to take a gradual approach to attacking the budget deficit.

As far as the bond market, the argument follows the same logic. At the margin, if Obama is less likely than Romney to quickly address the deficit, then we have less risk of a second recession but also more risk of longer-term inflation. Obama's policies in his first term haven't been particularly pro-growth, but I expect that lame-duck Obama will want to fund the many investments he has been discussing since before he was elected the first time. I think that we could see spending aimed at boosting jobs (and funded by cutting defense). In general, I expect lame-duck Obama to be very pro-growth, which likely won't play well in bond land.

Inflation is something that I think lame-duck Obama is likely to tolerate - it has never really bothered Democrats as much as Republicans. What a convenient way to deal with too much debt. More growth focus and a tolerance for some inflation, if I am correct, will lead to a lot of interest in hedges, like gold and oil. As far as oil and other fossil fuels, an additional driver of price is the likelihood of continued or even expanded regulation.

If I am correct so far, there are several parts of the market that should perform better than the overall market. Rallying stocks is typically better for small-caps, but I think Obama's potential reelection also kills the odds of large tax-cuts for multinationals, which would favor large-caps. For the record, Obama or not, I am bullish on small-caps.

I expect that Obama could turn to fiscal stimulus again, similar to what he did early in his first term. If I am correct, there are many publicly-traded companies to consider, and I certainly don't believe that this is priced in. While three years ago, the focus seemed to be more on road construction, this next round will likely be tied to other types of infrastructure.

Higher oil prices have been leading to massive shale investments (Bakken, Eagle Ford, Permian and other areas), and I expect that these trends will continue under Obama's second term. MLPs that invest in the infrastructure that connects these new basins to the end users (refiners) are likely to benefit. A Romney victory could lead to lower oil prices for several reasons, including reduced regulation and a weaker economy initially. MLPs are likely to look even better as a tax-shield at the enterprise level as tax rates rise under Obama.

Healthcare has struggled, especially device companies, with the uncertainty created by the Affordable Care Act. If one looks solely at the S&P 500 Healthcare sector, it is misleading, as the large pharmaceuticals that dominate the S&P 500 have done alright. Now is the time for device companies and insurance companies, which are likely to benefit from the certainty that ACA, good or bad, is a done deal. Many investors have been focused on the more immediate higher costs, but perhaps the focus will shift to the more longer-term benefits of expanded coverage.

One area that could continue to struggle is defense-related companies. With Obama likely not willing to cut spending in other areas (and possibly boost it to jump-start growth), defense spending is likely to be pressured. Within defense, I expect that the demand for what is known as ISR (intelligence, surveillance and reconnaissance) will fare best, but, even there, funding could be a challenge. Big contractors like Northrop Grumman (NYSE:NOC), Raytheon (NYSE:RTN) and Lockheed Martin (NYSE:LMT) have had great runs - seems like a good time to take profits.

It seems likely that Obama will be reelected. I have shared my thoughts about how his second term may impact stocks, bonds and certain commodities. As the campaign season heats up, we are likely to start hearing more details.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.