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Gridlocked DC to Grind Economy to Halt?

The consensus view of investors today and for the last six months is that a Republican win in the House of Representatives, and possibly the Senate, will mean business-friendly compromises and an overall legislative slowdown that cuts deficit spending. Historically, this has been among the most market-friendly set-ups in Washington. But today, we are dealing with no ordinary market.

“The problems facing our economy are serious, requiring real action on the part of political bodies,” said Dan Greenhaus, Miller Tabak & Co Chief Economic Strategist, in a note. “Simply put, gridlock is good when the private sector is humming along and government action is more likely to disrupt activity than enhance it. This is not the case today.”

Last week, the government said third quarter gross domestic product increased at an annual rate of just 2 percent, with most of that coming from a build-up in inventories. While it was up from second quarter’s 1.7 percent increase, it’s still not enough to lower the nearly double-digit unemployment rate.

“The domestic economy faces numerous challenges to growth - in the form of an over-leveraged consumer, still elevated joblessness and large fiscal imbalances (local, state and federal) - that need to be addressed post haste,” said Doug Kass of Seabreeze Partners Management. “A government divided is not a price earnings ratio expanding event nor is it a recipe for a new bull market leg.”

Investors buying ahead of this election are using the 1994 ‘Republican Revolution’ as their case study. They argue the wins will push President Obama to the middle and allow for compromises on issues like the Bush tax cuts. The difference between this time and the centrist 1996 Welfare Reform Bill is that this bipartisanship is on the clock.

The tax cuts on income and dividends are expected to expire at the end of the this year and the winners of the special elections in Illinois and West Virginia will be seated immediately, taking part in this debate.

And when the complete new Congress is sworn in next year, it will face a fragile market that experienced a ‘Flash Crash’ of nearly 1,000 Dow Industrial points in May, an economy growing barely more than population growth and a financial sector expected to implement a new regulatory bill amid a mortgage foreclosure documentation crisis.

“Gridlock has the potential to not produce an extension of the Bush tax cuts,” said Andrew Busch, global currency and public policy strategist for BMO Capital Markets. “Gridlock will not produce any meaningful legislation. If there is any crisis, this is not the Congress (Tea Party influence) to get anything done.”

Miller Tabak’s Greenhaus expects this new Republican-infused Congress to be negative on free trade and still not effective in restraining the entitlement spending.

To be sure, the majority of investors clearly disagree and are putting their money behind big Republican wins and the industries that stand to benefit most from their takeover.

Shares of utility companies , whose dividends will become more attractive under an extension of the tax cuts, and energy companies , which will benefit from easier restrictions on emissions and offshore drilling, were the biggest winners today.

“Corporations will feel more confident in the landscape that will exist after election,” said Stuart Frankel’s Steve Grasso. “Congress will be forced to get to the business of fiscal responsibility and getting out of the way of job creators. They will be forced to work together or they too will be held responsible in 2 years.”

* For the best market insight, catch 'Fast Money' each night at 5pm ET, and the ‘Halftime Report’ each afternoon at 12:30 ET on CNBC.

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Trader disclosure: On November 2nd, 2010, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders; Terranova owns (APA), (AAPL), (AXP), (C), (GOOG), (GS), (FCX), (IBM), (NOV), (ORCL), (PCP), (PEP), (PFE), (UPL), (VRTS), (XBI); Finerman owns (AAPL); Finerman & Finerman’s Firm owns (BAC); Finerman & Finerman’s Firm owns (JPM); Finerman’s Firm owns (MSFT); Finerman’s Firm owns (WMT); Finerman's firm is short (IJR); Finerman's firm is short (MDY); Finerman's firm is short (SPY); Finerman's firm is short (IWM); Finerman’s firm owns S&P 500 puts; Finerman’s firm owns Russell 2000 puts; Cortes is short (AAPL); Cortes owns (GOOG); Cortes is short (RSX); Cortes is long S&P 500; Cortes owns (K); Cortes owns (TSN); Cortes owns (CLX); Cortes is short crude oil; Cortes is short gold; Cortes owns U.S. Treasuries; Clifton owns (BA), (CNX), (FDX), (LLY), (LO), (MA), (MCO), (MO), (NSC), (PPA), (RHI), (SO), (TE), (X), (MUB)

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