You see, control of the Senate is very much up for grabs on November 4, and Republicans need just six seats to gain the bare majority of 51 (if they get 50, Vice President Biden can break the tie).
Currently, experts say there’s a 60% chance of Senate control changing hands… and a Republican Senate, combined with a Republican House, could mean a substantial shift in economic policy.
As income investors, we need to be prepared to adjust our portfolios should Congress swing to the Republicans.
Two Vastly Different Outcomes
Let’s take a look at how both a Republican- and Democrat-controlled Senate would affect us as investors…
If the Republicans win control of the Senate, monetary policy will become tighter. Most (though not all) Republicans want a tighter monetary policy than the Democrats, and Republicans worry about the effects of the monetary “stimulus” of the last six years.
Of course, Janet Yellen, in office until at least January 2018, will remain in charge of the Fed.
However, the Senate must confirm new Fed Governors, so the monetary hawks on the Federal Open Market Committee will be strengthened over time. More importantly, Janet Yellen must appear before Congress twice yearly; with Republicans in charge in both houses, she’ll probably trim policy towards their preferences.
Meanwhile, the current economic recovery is already five years old, and the stock market has risen over 100% since 2009. There must, therefore, be a significant chance of a market crash and accompanying recession before the 2016 elections.
If a crash is bound to occur, the Republicans, hoping to blame any trouble on President Obama, would want it to happen before the election.
Conversely, with a Democrat Senate, Yellen’s own preference for loose money will be given free rein. My guess is, in that case, interest rates will rise very little – if at all – before the 2016 elections, and we may see a further burst of “quantitative easing” bond purchases.
That would prolong the economic recovery as far as possible, something the Democrats want to ensure leading up to the 2016 election. Two more years of expansion and increasing employment before the election would make President Obama’s economic record look stellar, since he took over in a downturn.
A Republican Congress
Should the Republicans win, as is currently predicted, Congress is likely to make some significant policy changes.
Now, a Republican Senate won’t be able to push Republican policies over President Obama’s opposition – there will be no repeal of Obamacare, for example – but combined with a Republican House, it’ll be able to push the debate on issues such as public spending in its direction.
For starters, a Republican Senate would work to reduce the budget deficit from its current $486 billion – at least while the current expansion continues – rather than allowing it to increase, as the Congressional Budget Office currently predicts.
Conversely, defense spending would increase rapidly under a Republican Senate. In fact, Republicans have already expressed unhappiness with the sharp rundown caused by the “sequester” deal last year.
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Furthermore, a Republican Senate would likely try to close the U.S. Eximbank. This institution has come under considerable fire as an example of “crony capitalism,” lending taxpayer money at concessionary rates to foreign governments with poor credit ratings.
The Eximbank has its supporters within the Republican Party – large companies such as Boeing (BA) and General Electric (GE)benefit hugely from it, for instance – but if leadership wanted to give some red meat to the party’s ideological base, closing the Eximbank would be an obvious gesture.
Finally, on taxes, a Republican Senate is likely to move towards reforming the tax system by closing loopholes in both personal and corporate taxes and lowering the corporate tax rate. This would benefit companies currently paying close to the full nominal rate of 35%, while hitting companies such as GE that pay little tax.
Depending on the outcome of the November 4 election, I recommend looking at one of the following stocks:
If the Republicans win, look at major defense contractors (but not Boeing, which depends on U.S. Eximbank).
For example, Lockheed Martin Corporation (LMT) is currently trading at 18 times historic earnings, or 15 times projected 2015 earnings. It also has a decent dividend yield of 3.5%. LMT has a strong defense business, and it recently announced a breakthrough in nuclear fusion technology. While this won’t produce significant earnings for a decade or more, it does provide a very nice upside kicker.
In the event of a Democrat victory, I can’t help being cynical and recommending a stock group I generally pan because of its vulnerability to interest rate rises: the residential mortgage REITs.
As discussed above, a Democrat Senate will attempt to keep interest rates as low as possible for as long as possible, and Fed Chairman Janet Yellen is temperamentally inclined to go along with them.
That makes Annaly Capital Management (NLY), which is carrying an exceptionally attractive yield of 10.6% and trading at 85% of book value, look like a good short-term speculation – at least for the next six months or so. At the very least, we can collect an excellent income while we hold it.