As we rush headlong into the presidential elections now is a good time to consider new strategies that may become appropriate depending who wins the presidential election. At the time I write this the outcome of the election is far from clear. While I believe neither candidate offers a significantly better scenario for the overall future of the markets, both candidates have made policy proclamations that can give us a basis to be prepared for the coming year.

Scenario One – Bush is re-elected: While this outcome probably causes the least change from your current strategy, it does bear some consideration. Expect no increase in taxes but a necessary continuing increase in issuance of government bonds. Talk of the crowding out effect from financing the deficits will heighten and will most likely act to cause further investor avoidance of bonds. In so much as some off shore investors are disappointed in a Bush re-election expect that investment opportunities abroad continue to outperform as these marginal investors shun the US. Continued low taxes and fiscal stimulus are likely to keep our economy relatively strong with good earnings prospects and improving balance sheets. My recommendations in this scenario are to overweight international equity and further underweight government bonds in favor of short corporate and municipal bonds.

Scenario Two – Kerry is elected: John Kerry has made no secret of his intention to raise taxes on the more affluent. Expect that one of the first things to go is the 15% rate on long term capital gains. If you have positions of low basis stock that you want to diversify out of now is definitely the time. In fact, in some cases it may even make sense to sell and buy back the same stock just to take advantage of the lower rate while it lasts. Regardless of the outcome of the election, it’s unlikely this rate will ever be lower. Don’t expect a big change in defense spending as Kerry will be anxious to prove that he is pro defense. The market, however, may assume spending cuts in defense that could provide some interesting buying opportunities. Interest rate increases may slow or pause as the Fed waits to see what if anything comes of the tax increases. While not a fan of higher taxes, Greenspan has been very vocal about balancing the budget and would likely adapt his moves to accommodate any effort toward lowering the deficit. This will present a more favorable scenario for bonds. Kerry has also suggested he would consider cutting corporate tax rates so in this scenario it may make sense to skew your equity portfolio toward larger companies that tend to pay more tax. International stocks should still do well but not necessarily outperform the US so you may want to reverse any overweighting in this sector. In general, if Kerry is elected my recommendation is to consider taking long term capital gains, reduce any overweighting in international stocks, maintain or possibly increase your bond exposure (especially municipals), and lean more heavily toward large cap stocks, particularly those with higher tax rates.

Preparing for the results of a presidential election is a useful exercise but be sure you don’t loose sight of your basic diversification targets and continue to maintain a balanced portfolio. None-the-less, we should all begin to think through the "what if" scenarios. Please feel free to call me if you have any questions.

Randy Gridley