Wall Street's hope on U.S. election: Divided government

NEW YORK (Reuters) - Investors mesmerized by the neck-and-neck U.S. presidential election may wonder which political party is best for their stock portfolios, but the savviest minds on Wall Street already have the answer -- divided government.

The stock market has done very well, thank you, gaining nearly 20 percent annually in the last eight years with a Democrat in the White House and a Republican-controlled Congress. If those positions reversed, that would be fine, but one political party having total control is bad news for investors, history and Wall Street experts say.

Divided government creates legislative gridlock, canceling out the extremes of each party's policies -- the Democrats' spending plans and the Republicans' deep tax cuts, which both could spur inflation. That will free up market forces to propel the stock market higher, experts said.

"If you had a clean sweep across the executive office and Congress, then either party would initiate its programs -- whether it's spending or a combination of spending and tax cuts -- and whatever surplus there is would be gone in the flash of an eye," said Michelle Clayman, chief investment officer at New Amsterdam Partners LLC, which oversees $1.1 billion.

With less than two weeks to go until the election and the two key candidates, Republican George W. Bush and Democrat Vice President Al Gore running at a dead heat, Wall Street is hoping for more of the same: a Democrat in the White House and a Republican Congress.

"That's probably the best outcome for the market," Clayman said.

History is backing up Clayman's comments.

Over the past century, a "split" government has yielded stock investors an average annual return of about 8.7 percent, while a government with one party ruling both the White House and Congress yielded 7.8 percent a year, according to research by brokerage Instinet Corp., a unit of news and financial data company Reuters Group Plc.

Instinet measured stock market returns by taking the average return of the Dow Jones Industrial Average from 1900 to 1927, and the broader Standard & Poor's 500 Index from 1928 to the present.

The combination of a Democrat president and Republican-led House of Representatives and Senate has proven optimal for the stock market, yielding an average annual return of about 13.5 percent.

Eight of the 10 years when this happened, however, have been during the Clinton years, when returns have averaged about 19.2 percent annually.

"To give the Republicans credit, some of the policies were initiated in the Reagan and Bush years, and there has a been a carry-over through the Clinton era," Clayman said.

On a one-party ticket, the market clearly has preferred a Democratic government. With a Democrat-controlled White House and Congress, the annual returns averaged about 9 percent. With Republicans in full control, they averaged around 6.2 percent.

"The analysis debunks the majority-held opinion on Wall Street that a Republican administration and/or Republican-controlled Congress is always the optimal political climate for the capital markets," Instinet said.

Potential voters are split on whether Gore or Bush is better for Wall Street, according to a recent Reuters/MSNBC poll by John Zogby.

In the survey of 1,207 likely voters, 32.6 percent of respondents said that a Gore administration would be better for the stock market, while a slightly higher 35.1 percent said Bush would be better. Another 23.6 percent were not sure, while 8.3 percent said neither would be better for Wall Street.

There is little doubt, however, that the outcome of the election will have an impact on specific market sectors.

"Gore's not a reason to be in or out of the stock market, he's a reason to be in or out of certain stocks, and you can say the same thing about Bush," said Tom Gallagher, political economist at ISI Group.

Energy, tobacco, health care, pharmaceutical and defense industries could get a boost if the Texas governor wins, and big business is likely to cheer his push for tax cuts.

But the fear is that such policies -- specifically tax cuts -- could send economic growth speeding out of control. That could force the Federal Reserve to hike interest rates again, and potentially trigger a recession and hurt all stocks.

A Bush White House would lend a more industry-friendly tone to any health industry legislation, especially with the backing of a Republican-dominated Congress, experts said.

"The odds of getting (a bill) that the industry can feel much better about in a Republican administration are high," said Charles Gabriel, a political analyst for Prudential Securities.

Bush's drive for social security reform, which might allow income-earners to divert a chunk of their social security savings into private investment accounts, could also benefit stocks, particularly those of financial services companies, analysts said.

Gore, on the other hand, has resisted social security reform and has been outspoken about cutting costs of prescription drugs. That may gouge earnings and streamline approval for competing generic drugs and treatments, the pharmaceutical industry fears.

Industries expected to benefit under a Gore administration include government-backed mortgage market stalwarts like Fannie Mae and Freddie Mac , analysts said.

In addition, Gore may back the Justice Department's strong stance against software powerhouse Microsoft Corp. , which has been locked in an anti-trust lawsuit. That is bad news for Microsoft, but it might give a competitive edge to some of its rivals, such as Sun Microsystems and America Online .

The insurance industry, too, could get a lift from a Democratic administration, which is viewed a more likely to push for federal insurance regulation, analysts said.

Presidential hopefuls have taken the spotlight for the time being, but analysts said the true power pulling the markets' strings is backstage: the Federal Reserve.

It's up to Fed Chairman Alan Greenspan or the heir to the helm of the U.S. central bank to steer the economy clear of choppy waters and into an environment of solid growth and low inflation, experts said.

"Greenspan or his heir will be guiding the markets higher and that will matter more than whether it's candidate A or candidate B," said David Sowerby, a market strategist for investment firm Loomis Sayles. And while the neck-and-neck race to become commander- in-chief will not be ignored, a whole slew of issues -- from the turmoil in the Middle East to the price of a tank of gas -- may weigh more heavily on investors' minds, analysts said.

Wall Street has been battered in recent months by a slew of companies confessing they will likely receive worse marks on their corporate scorecards in the quarters ahead, including high-tech giants like Intel Corp.

"On the laundry list of things that would give me high blood pressure, escalating inflation, volatility in oil, and more mea culpas in earnings reports are more important than whether its Bush or Gore," Sowerby said.

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