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Thursday Look Ahead: Markets Watching Fed as Election Looms

Markets worldwide have been obsessing about the outcome of the Fed's November 3 meeting, but analysts, meanwhile, have been handicapping how stocks and sectors might perform, based on the outcome of the November 2 Congressional mid-term elections.

New York Stock Exchange
Oliver Quillia for CNBC.com
New York Stock Exchange

Energy companies could be among the winners in the upcoming election if Republicans increase their numbers in Congress as expected.

So far, analysts agree the markets are pricing in a new era of Republican control of the House of Representatives, and that Democrats will continue to hold the majority in the Senate.

"I think investors have fully baked in that the Republicans are going to take over the House, and they'll pick up about 55 seats. They need 39 to take over the majority," said Dan Clifton, head of policy research at Strategas Partners. "Investors don't believe Republicans will take over the Senate...they think they'll pick up seven seats."

"If that's fully priced in at this point, then you just get a relief rally," Clifton added.

But on the outside chance that Republicans gain control of the Senate, Clifton expects a major rally. If the Democrats retain the House, stocks could see a sizeable sell off.

"There's a lot in the air for energy in this election," said Clifton. Republicans would have a more favorable industry view on issues of cap and trade, taxation, offshore drilling and Environmental Protection Agency oversight.

Clifton sees municipal bonds, dividend paying stocks, infrastructure companies, clean energy firms and communications companies as better bets if Democrats were to sweep.

Stocks Wednesday reacted to speculation about quantitative easing, and as usual, ignored the election. The Dow was down 43 at 11,126, and the S&P was down 3 at 1182. The dollar also fell and Treasurys sold off after a report in the Wall Street Journal put the size of the Fed's Treasury purchases, under QE, at a few hundred billion dollars, well below the high end of expectations.

"What's interesting is a lot of the expectations for QE2 are also the sectors that do well under the Republicans—coal, energy, utilities and they're all selling off today," said Clifton.

Managed care companies could also benefit from a Republican win in the House but the GOP would have to take both Houses for gains to stick, he said. He expects the Republican House to try to roll back health care reform, but the effort would end there.

"You get a rally in managed care, but it's temporary. Energy has real issues...if the Republicans win the Senate, then that really changes the game," he said.

In addition to working up new regulations on offshore drilling, Strategas points out the EPA is studying fracking with the goal of taking regulatory authority over the process, and the GOP is more likely to retain the current state run regulatory structure.

Cowen and Co. director of quantitative strategy Paul Lieberman looked at polling information and related stock reaction to them. He said when Republicans do better, industries like paper and forest products, automobiles and independent power producers perform better.

In a note, he wrote that specialty retail, multi-line retail, leisure equipment, hotels, restaurants and leisure also benefit because taxes are a key issue to those groups. Mining and diversified financials also do better with Republicans. Democratic spending on stimulus projects has made other sectors like water utilities, construction and engineering and road and rail more likely to do better with a Democrat-controlled Congress.

Clifton expects whatever type of Congress is elected to turn its attention pretty quickly to taxes, both the Bush tax cuts and other issues, like unemployment insurance.

"Investors know what the outcome is going to be, but they don't know what the outcome means. You're at least going to get a one-year extension (of the tax cuts) and you're going to get it in the last week of November, first week of December...there's so many tax cuts that are going to expire if they don't get extended," he said.

He also said another 27 million Americans would be impacted by the AMT, and it is unlikely President Obama would allow that to happen.

"The big story here is that within a month's time, Congress has the ability to pass on $300 billion in tax increases or nothing...if they don't take a vote it's $300 billion automatically. Those are two extremes," said Citigroup economist Steven Wieting. He said his baseline case is that the Obama administration gets close to the amount of tightening it wants. "If you look at it, it has more impact on the economy than QE."

"This is a big issue and they have tremendous potential to influence the economy next year, and we should start to get answers in the end of November," said Wieting.

What Else to Watch

The big economic headline Thursday is weekly jobless claims, at 8:30 am. The Treasury auctions $29 billion in 7-year notes at 1 p.m.

"Rates have backed up steadily over the week and the 7-year sector tends to find solid sponsorship," said Ian Lyngen, senior Treasury strategist at CRT Capital.

There are also dozens of earnings reports, including Exxon Mobil, 3M, Sanofi-Aventis, Barrick Gold, Colgate-Palmolive, Fortune Brands, Duke Energy, Motorola, Potash, CME Group, Blackstone Group, Avon Products, AutoNation, Williams Cos, Starwood hotels, Thomson Reuters, Celgene, Cardinal Health and Noble Energy, ahead of the open.

Microsoft reports after the bell, as does Genworth, MetLife, Sunoco, Cliffs Natural Resources, Expedia, BMC Software, Coinstar and Monster Worldwide.

- Follow me on Twitter @pattidomm.

Questions? Comments? Email us at marketinsider@cnbc.com

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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