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A Two-Faced Strategy to Playing the Election

If election-year patterns are any guide, investors can expect solid gains for their 2012 stock portfolios.

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Indeed, the Standard & Poor’s 500 index has risen in the final seven months in 13 of the last 15 presidential elections, according to the Stock Trader’s Almanac. And since 1896, the Dow Jones Industrial Average has produced an average 9 percent gain during election years when an incumbent president sought a second term — regardless of the outcome.

But the fortunes of individual sectors will also rise and fall in the years ahead depending on which political party wins the White House in November, since policy decisions impact corporate profits.

That spells opportunity for tactical investors who know where to look.

If Romney Wins

A win for Republican presidential candidate Mitt Romney, for example, would likely bode well for dividend-paying stocks, mainly utilities, telecommunications and consumer staples, says Sam Stovall, chief equity strategist for S&P Capital IQ.

That’s because Romney would hold the dividend tax rate at 15 percent rather than allowing the Bush-era tax cuts to expire, which would push dividend taxes to ordinary income rates.

Under President Barack Obama, the wealthiest taxpayers could pay 39.6 percent on dividends — assuming the Bush tax cuts expire — plus a new 3.8 percent tax on passive income from dividends, interest and capital gains, compliments of the 2010 health care law.

US Republican presidential candidate Mitt Romney shows a chart as he speaks during campaign event at Watson Truck and Supply in Hobbs, New Mexico, on August 23, 2012.
Jewel Samad | AFP | Getty Images
US Republican presidential candidate Mitt Romney shows a chart as he speaks during campaign event at Watson Truck and Supply in Hobbs, New Mexico, on August 23, 2012.

“Obama has been talking about raising taxes for those people making $200,000 or more, and households making $250,000 or more, so a lot of investors would be caught up in that,” said Stovall. “The dividend tax for them would effectively triple.”

A selection of stocks with the best investment recommendations by S&P analysts and the highest dividend yields include Philip Morris International , Altria Group , Lorillard , Frontier Communications , Windstream , and UGI Corp .

The energy sector, or at least those companies engaged in conventional production, may also favor a Romney White House, says Stovall.

The GOP candidate has said he would authorize a dramatic increase in the domestic production of oil and natural gas to enable North American energy independence by 2020.

His plan would remove federal roadblocks to fracking, authorize drilling on federal land and off the East Coast, and green light the Keystone XL pipeline to transport crude oil from Canada to refineries throughout the U.S. Obama has delayed any decision on the pipeline until 2013.

In addition to dividend payers and energy companies, the banking sector may also benefit from a Republican administration, as many believe the party would ease restrictions imposed upon the financial services industry by the Dodd-Frank Act, a federal law that places regulatory oversight into the hands of the government, says Stovall.

Some S&P stock picks within the sector include: Huntington Bancshares , J.P. Morgan Chase , Citigroup , U.S. Bancorp and Comerica .

If Obama Wins

Unsurprisingly, an entirely different basket of stocks would cheer if Obama were re-elected.

Homebuilders are among them, as the current administration continues to enact programs to bail out delinquent homeowners and speed the resolution of the foreclosure mess.

Barack Obama
Barack Obama

“As a result, we are likely going to end up with a leaner inventory of foreclosed homes, which therefore creates demand for new homes,” said Stovall, noting the S&P has no recommendations currently in the homebuilding sector.

Contrary to popular belief, healthcare stocks may also benefit from another Obama term.

While the $85 billion in fees imposed upon drug companies over the next decade to help pay for Obamacare will negatively impact earnings, the individual mandate requiring all Americans to have government-approved health insurance will more than offset any losses, says Alex Morozov, director of the healthcare team for fund tracker Morningstar.

“That’s a gigantic mitigating factor for pharmaceuticals,” he said. “Even though they may take an earnings hit as a result of the fines, the mandate provides a very needed inflow of patients who were previously uninsured. And when patients have insurance, they tend to utilize it, so consumption of healthcare services and products tend to accelerate.”

That’s good news for stocks like Pfizer , Novartis , Johnson & Johnson and Roche, says Morozov.

Medical device companies could also thrive, despite the 2.3 percent excise tax the Affordable Care Act would impose on medical device revenue starting next year.

“The device sector is completely out of favor right now, but we have more investment recommendations there than any other sector,” Morozov said. “The excise tax is clearly a headwind for the industry, but we’re contrarian on this because we think the sector positives are still there, including a demographic shift that benefits these companies.”

Morningstar’s top medical device company picks: Covidien , Medtronic and Stryker .

At the same time, Stovall notes gold would remain strong following an Obama re-election, as investors flock to save havens.

“Within the metals, gold would do better for all the wrong reasons,” he said. “It would benefit from a lack of confidence in Obama’s economic turnaround and an expectation that the economy will need additional stimulus.”

The outlook for alternative energy companies, however, remains mixed.

While wind, hydro and solar energy companies have had a friend in the current president, who approved federal tax credits to help develop renewable energy, the subsidies that support wind power generation are set to expire this year, and those aimed at solar companies will expire in 2016.

Given the magnitude of economic challenges facing the future president, there’s little impetus from either party to create new subsidies, says Christopher Blansett, an energy analyst for J.P. Morgan Chase.

“It’s status quo to slightly negative for alternative energy even if Obama wins,” he said. “But if there’s a shift to the GOP, either in the White House or if Republicans take control of Congress, it would definitely be negative for alternative energy.”

Why? Republicans would likely try and eliminate renewable energy subsidies based on commentary from Mitt Romney and other leading members of the party, and simultaneously enact policy that favors competing conventional technology.

Beyond The White House

Investors who intend to adjust their asset allocation based on the election results, however, should be wary of historical trends — and assumptions about how party affiliation impacts the market.

Conventional wisdom, for example, has long maintained that Republican administrations, wielding tax credits and business friendly regulations, are better for the markets.

Not true, says Jeff Hirsch, chief market strategist with Stock Trader’s Almanac.

“Overall, we’ve shown that the market does better under Democratic presidents, but the dollar does better under Republicans,” he said, noting that that suggests inflation may trend higher if Obama wins a second term.

Wildcards

Regardless of who wins the Oval Office, says Hirsch, the market is likely to get a comeuppance in 2013 and 2014.

Wendy Connett | Robert Harding World Imagery | Getty Images

Changes in the balance of power in Congress as well as how Washington handles the fiscal cliff have the capacity to shake up the broader market.

Even still, winners will emerge.

“The individual sectors and stocks that will outperform will present themselves in the first 100 days of the next administration,” Hirsch said, noting investors must exercise patience, caution and superior stock selection. “We pinpoint stocks that are growing, yet are still undervalued and maintaining momentum.”

Rather than choosing sectors that may favor Romney or Obama, tactical investors would be better served picking equities that are likely to produce returns regardless of who gets the majority vote, Stovall says.

“If the candidate or party chooses not to focus on a particular issue, then maybe you have purchased stock in anticipation of something that does not materialize,” he said. “Go for those stocks that are likely to do well under either administration and that are closely tied to the fortunes of the global economy.”

Telecommunication stocks are a good example.

As the highest-yielding sector with the S&P 500, telecom stocks may indeed benefit from a dividend friendly Romney administration, but Stovall notes these companies have consistently raised their dividend regardless of party affiliation within the White House.

“Also, one of the components of the Medicaid program is the Lifeline prepaid card, which provides a prepaid telephone card to recipients of food stamps,” Stovall said.

Natural gas stocks may also do well under either president, he says, since Romney would encourage domestic production, and Obama has publicly embraced natural gas as a transportation fuel.

Even tactical investors, however, should maintain an asset allocation befitting their time horizon and risk tolerance, says Stovall.

“Investors should look inward and adhere to what Dirty Harry once said: “A man’s got to know his limitations,’” he said.