Valliere: The Post-Election Climate, What Investors Need to Know

In Washington, the election outcome is a foregone conclusion – a solid GOP victory in the House, well in excess of the 39-seat magic number, with the Democrats narrowly retaining the Senate. Not only is this outcome conventional wisdom inside the Beltway, but it appears to be fully priced into the markets as well.

Thus the real focus in this city is on the post-election environment. It strikes us that there are three distinct stories: one for the Democrats, another for the Republicans, and still another for investors.

Democrats: The finger-pointing and recriminations will begin within hours of the election. The spotlight will shine on President Obama – will he pivot to the center as Bill Clinton did in 1994 after the Newt Gingrich landslide? We’ve talked with key players in both parties, and there seems to be a consensus that Obama will have great difficulty moving to the center – largely because he, unlike Clinton, isn’t remotely a centrist.

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A fierce power struggle will occur immediately after the election in both Houses.

As in the U.K., where leaders step down after a defeat, Nancy Pelosi is likely to resign as Speaker, setting the stage for Rep. Steny Hoyer to lead the Democrats.

Hoyer is relatively moderate and is a close friend of the likely new Speaker, Rep. John Boehner, so the left naturally is suspicious.

Republicans: The Tea party has been more of a blessing than a curse for the GOP (except in Delaware) but now the relationship may get more complicated. Sarah Palin is a genuine superstar and probably is running for president – but will Republicans back away from her because of concerns that she can’t win a general election?

More importantly in 2011, how aggressively will the GOP push its agenda? Republicans won’t have the votes to overturn anything that passed in the last two years, but they will pursue spending restraint. Some firebrands have already threatened to shut down the government over spending issues; that tactic backfired when newt Gingrich tried it nearly two decades ago.

Investors: The history is quite clear – gridlock is good for the markets; it unquestionably was in 1995-2001, when Clinton was restrained by a conservative Congress. The activist Obama agenda will hit a brick wall next year – no cap and trade bill, no card check, etc. And spending may be frozen.

Your Money Your Vote - A CNBC Special Report
Your Money Your Vote - A CNBC Special Report

But we would caution that the post-election environment will not be totally positive for the markets – Obama will still have an effective veto, and the regulatory agencies will continue to be aggressive.

The biggest concern for investors between now and year-end involves the Bush tax cuts, which expire on Dec. 31. We think moderate Democrats will join Republicans and extend the cuts for everyone, largely because the economy is too fragile to raise taxes on anybody.

While an extension for everyone is the likely scenario, it’s not certain, and until this issue is resolved there may be a cloud over the markets – even if the GOP romps on Nov. 2. Unfortunately, this crucial tax issue may not be resolved until a week before Christmas in a lame duck session.

Greg Valliere is Chief Political Strategist at the Potomac Research Group, a Washington-based firm that advises institutional investors on how government policies affect the markets. Greg has covered Washington for over 30 years, starting his career as an intern at The Washington Post, then co-founding The Washington Forum in 1974 to bridge Wall Street and Washington. He has held several positions, including Director of Research, for Washington-based firms, including the Schwab Washington Research Group. Greg is an exclusive commentator for CNBC-TV, where he appears regularly on most of the network’s programs.