What Iowa means for Wall Street

Hillary Clinton and Ted Cruz
Scott Morgan | Reuters; Luke Sharrett | Bloomberg | Getty Images
Hillary Clinton and Ted Cruz

For months, Wall Street has presumed Hillary Clinton would win the Democratic party's nod and go on to win the presidency, but Monday's Iowa caucuses suggest the race could be tighter than expected.

Clinton on Monday barely edged out Sen. Bernie Sanders, with both close to 50 percent in the Iowa caucuses. Now she faces him in New Hampshire next week, a race the Vermont senator is expected to win with a regional advantage. So that makes the Feb. 27 faceoff in South Carolina very crucial for Clinton, who is expected to be stronger in the South.

"If the probability increases that Sanders wins the nomination then it increases the probability that the Republicans would have complete control of the government after the election," said Dan Clifton, head of policy research at Strategas.

On the Republican side, Sen. Ted Cruz came in first, upsetting Donald Trump who went into the Iowa caucuses as the perceived front-runner. But both of them were followed closely by Sen. Marco Rubio, who took 23 percent to Trump's 24 and Cruz's 28 percent.

"The market basically reads a win as Trump losing, which increases the odds that the establishment will coalesce around Rubio. I think the big impact right now is you have the Republicans starting to normalize, and there's now questions being raised on the Democratic side," said Clifton.

"It's probably too early for a major market impact, but the big change is Rubio is now the favorite and Trump no longer is and that creates a more stable type of candidate. You know what he's going to do," he said, adding investors would view Rubio favorably.

It's not that the market loves Clinton, but she was viewed as a known entity and relatively moderate candidate. But Wall Street has been hoping for a more mainstream traditional candidate on the Republican side, and Rubio is more consistent with that than Trump or Cruz.

"The fact Trump came in second would probably be a positive in this marketplace but it is offset by the strong showing Bernie Sanders had. The worst-case scenario would be coming out of New Hampshire with the two leaders Donald Trump and Bernie Sanders," said Art Hogan, market strategist at Wunderlich Securities.

Sanders represents the left wing of the Democratic Party, and he has pushed ideas such as free tuition at public colleges and other programs that would increase government spending. "He's proposing huge tax increases, and he's not shy about it," Clifton said.

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Stocks were sharply lower Tuesday as oil declined 3 percent, for a two-day drop of more than 8 percent. David Kelly, chief global strategist at JPMorgan Funds, said the market Tuesday was not reacting to the election, but the outcome in Iowa was actually favorable for markets.

"Markets don't like uncertainty, and the more extreme the candidates that get nominated the greater the uncertainty. The fact that on the Democratic side, a more centrist candidate won, although narrowly, and on the Republican side, there was a swing towards a more centrist candidate. I think in both those cases, those things would be regarded as market friendly," said Kelly. He said the centrist candidates are those less likely to make big policy changes that would unsettle markets.

"I think the coalescing of the Republican voters around one candidate who could be more appealing to independent voters is probably a positive for the Republicans," said Kelly.

Clifton said Cruz, who is at the conservative end of the Republican Party, does not have the staying power to win the GOP nomination. Although he could prevail in other primaries, he would not win big important states like California or Illinois.

Rubio needs to keep the momentum going and place at least second in New Hampshire, Clifton said.

"The point is that he has the highest favorability rating in the party," said Clifton. "Usually people with high favorability ratings are the ones that can weather the storm. (Jeb) Bush put $20 million against him and he's still doing OK. ... It's all based on the idea that Rubio comes in second place in New Hampshire."

Analysts say Trump, although well-known on Wall Street, was not embraced by Wall Street because of his unpredictability.

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"I think the macro sentiment that's building right now is you have a populist revolt that's happening, and the implication of that is you're going to have less trade, possibly higher taxes," said Clifton.

But Trump is also viewed positively by some because there is a perceived lack of American leadership on the world stage, and some investors believe that's one area he could improve, Clifton said.

"There's just an uncertainty to him," said Clifton. "We have no idea what he's going to do. He's brand new. He's totally unpredictable."

If Clinton starts to look as if she will not be the winner, analysts expect the market to react, as it adjusts to the policies of the new front-runner.

"She's got a greater than 50 percent probability to be the next president. I would say that's the consensus on Wall Street and our view is that probability is going to whittle down over the next few months," said Cilfton.

He said if Sanders were to get the Democratic nod, the Democratic Party may broker a deal to run another candidate, like Vice President Joe Biden, who in October said he would not run.

Among topics investors will focus on during the election are the minimum wage, tax reform, health-care reform, financial services reform, energy and climate change, and cybersecurity, according to Barclays strategists.

While the overall market has not reacted to the election, sectors have. For instance, the iShares Nasdaq Biotech ETF has fallen more than 30 percent since Clinton first tweeted Sept. 21 about Turing Pharmaceuticals' steep price hike for Daraprim, a drug used to treat parasitic infections. She called the price increase "outrageous" and announced in the tweet that she had a plan to take on price gouging.

Clifton said the fact that Trump, a Republican, also joined the chorus on drug prices last week created even more uncertainty around the pharmaceutical sector when he said there should be Medicare negotiations for prescription drugs.

Democrats also have called for more regulation of the financial industry, while GOP candidates have proposed removing some of the new financial services legislation adopted since the financial crisis.

"Specifically, Bernie Sanders voted for a bill to recreate the Glass-Steagall Act that previously separated investment banking from retail banking. Hillary Clinton has proposed further strengthening the Dodd-Frank Act while at the same time introducing a high-frequency trading tax Conversely, Donald Trump, Marco Rubio and Jeb Bush have discussed repealing the Dodd-Frank Act while Ted Cruz and Ben Carson have criticized the creation of the CFPB (Consumer Financial Protection Bureau)," wrote the Barclays strategists.

They said further regulation would hurt the S&P 500 bank stocks, which have seen their return on equity fall to less than 10 percent, from the more than 15 percent before the financial crisis. On the other hand, GOP efforts to repeal Dodd-Frank would be viewed as favorable, but the analysts do not anticipate any near-term changes in financial services legislation.

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The candidates also have been divided on energy and climate change.

"Bernie Sanders has argued against fossil fuel subsidies, offshore oil drilling, pipeline projects and natural gas fracking while Ted Cruz, Donald Trump and Marco Rubio have downplayed global warming," the Barclays analysts noted. On cybersecurity, they expect it to get more attention from the candidates, and that could benefit the information security stocks.