As the polls had widely anticipated, Democrats defeated the Republicans in Congress and also gained control of the Senate by a narrow margin in the U.S. mid-term elections in early November. As attention now turns to the Presidential elections of 2008, President George W. Bush will need to find ways to increase bi-partisan cooperation with Democrats like Nancy Pelosi, who is poised to become the first female Speaker in U.S. history. What do the mid-term elections mean for investors and the stock markets? How will they affect American relationships with emerging economies like China and India? What will be the fate of Bush’s tax cuts? To discuss these questions and more, Wharton finance professor Jeremy Siegel, who leads Wharton Executive Education’s Securities Industry Institute program, spoke with Knowledge at Wharton.
Knowledge at Wharton: You wrote in your newsletter that “If the Democrats sweep Congress, there will be a battle for the soul of the Republican Party.” Has this battle begun, and how is it shaping up?
Siegel: It’s a little bit too early to be engaged. There is a lot of soul searching by the Republicans — they’re going to have to think about what direction they want to go in. I don’t think that we’re really going to see that engaged until the New Year, when I believe that John McCain will announce that he is going to be a candidate and there will probably be others. I think that throughout 2007 there will be the battle for the soul of the Republican Party.
Knowledge at Wharton: And what effect do you think this election will have on the stock market?
Siegel: Well, so far stocks have taken it quite well. I thought that there might be a little bit more reaction if the Senate fell to the Democrats, but there really hasn’t been that much, because the rest of the economic news has been so very, very good. A Democratic shift was pretty well discounted by the market. The polls were pretty right-on when you got down to it; at the end they said the Senate would be just about a deadlock and that it may go 51-49 for the Democrats and that the Democrats were definitely going to take over the House. So, I think that was pretty well built into the price.
Now, we did get a reaction in the specific sectors. Clearly the pharmaceuticals suffered as expected. Democrats are going to be much tougher on the drug companies and managed care …. Democrats are going to negotiate much harder on that. Technology has done well. Actually, the tech companies have been supporters of Democratic candidates and that could be one reason why we have that.
We’ve had some relative shifts that have taken place. We have a little bit of a drop in foreign markets because the Democrats, at least according to their rhetoric, are not as pro free trade as the Republicans. There is a little bit of concern [about] restrictions on that side. But overall, I think the good economic news has trumped the election to keep the stock market on an upward pace.
Knowledge at Wharton: Do you think that these elections will affect our relationships with [markets such as] India and China?
Siegel: I hope they don’t. The Democrats have talked tougher on loss of jobs and outsourcing. They’ve talked tougher on Wal-Mart, for instance — you know, the firms that do so much business with China — and that is a concern, I think. However, one has to remember that we still have a Republican President for two more years, and certainly the Democrats do not have enough votes for a veto over-ride. I don’t think that on any real trade issue, that puts any high restrictions on the trade.
I’m hoping that trade stays open, as I have said many times. I think it is very important for the United States. I think it is very important for keeping inflation low, the cost of living down. The imports from the emerging nations are going to be an increasing part of our economy in the future, and I hope that this is not blocked by the Democrats.
Knowledge at Wharton: Would you say that maybe some of the equilibrium that you are referring to comes from the fact that Congress is becoming more moderate on both sides, with moderate Republicans and Democrats winning?
Siegel: Right … clearly this was not like a leftist lurch. I think the war in Iraq was the major factor. I’ve always thought so. In my opinion, it’s been very poorly run by the Bush administration. The whole Mid-East policy has been poorly conceived and poorly run, and I think that basically the electorate essentially gave that message to them last week.
You know the old Democratic issues of the distribution of income, the rich getting richer, and the tax cuts for the rich — I don’t think that cut at all. And I don’t think that there was any mandate to do any really big things on domestic economic issues. I think there is a movement towards energy conservation; more concern about global warming, carbon emissions, etc. and so on. Clearly no one likes gasoline being high priced, but the prices have come down on that and particularly on natural gas. So I don’t think that was an overriding issue. I think that it really was the war in Iraq and the international aspect of this that eventually did in the GOP.
Knowledge at Wharton: Looking ahead to Nancy Pelosi’s presumed leadership position, what is her track record on business issues?
Siegel: Well, she’s presented a moderate face and we don’t know what exactly is going to come of that. Clearly, Democrats do not have the ability to force through their agenda by any means, especially with a Republican President that can veto anything that he wants.
Look at how much trouble the Republicans had when they had a majority in both the House and the Senate and the Presidency. And yet they got nowhere with Social Security, it was tough sledding on the tax cuts, etc. and so on. One could overstate the Democratic agenda. I think there is going to be a lot of positioning for 2008. Clearly if the Democrats hold Congress and capture the Presidency — then an agenda can be brought through.
But in the next two years, I don’t think that will happen. Now again, the tax cuts, as we all know, don’t expire until 2010. So, really there’s not likely going to be any tax legislation in these next two years. That’s why the 2008 elections are so very important because all of those tax cuts on dividends, capital gains and even the tax brackets all expire in 2010. They have to be renewed in Congress, otherwise they lapse to the old rates — and that’s going to be a really big fight, but that’s way in the future.
Knowledge at Wharton: In the interim, do you think that SEC enforcement will be impacted at all?
Siegel: Well, it’s hard to say. The truth of the matter is that although there’s talk about control of hedge funds and so on, the financial markets are pretty vibrant, they’re pretty flexible, and stocks are up. With the scandals of the past, we’re getting prosecutions with Enron, etc. and so on. That was of an era that ended years ago, the mutual funds etc. I don’t think that there is a public mood that we have to do a lot of corporate sweeping.
The option back-dating clearly is an issue, but I don’t think that it will hold the [public’s] interest — let’s say [like] the mutual funds scandals or of course the quite spectacular Enron collapse that we had in 2000-2001. Those I think had much greater impact than the back-dating on options. CEO pay is always an issue and has been, but again I don’t see that as cutting really, really deep, and I don’t know how much Democrats will want to push on these issues.
Knowledge at Wharton: Another issue that has been in the spotlight is minimum wage. Do you think that that will be affected at all?
Siegel: Yeah, I think that every state that had an increase in the state minimum wage on the ballot — it was passed by the electorate. This is one issue where enough Republicans could join the Democrats and could actually make this veto proof. It’s very likely that a rise in the minimum wage will be put into law in the next two years or certainly offered to Bush. And probably the Democrats would love for him to veto it and then ride on that election issue in 2008, given that it does have very, very substantial popular appeal.
Now as an economist, I can make a lot of objections about minimum wage cutting down on jobs and especially youth jobs. … We have very low unemployment rates right now, but there is the feeling on the part of many people, right or wrong, that in the sense of fairness we should raise the minimum wage. It is a very popular issue and that is one issue that is very likely to be raised in the next two years.
Knowledge at Wharton: In closing — if we could turn to the very short term — as we head into the holiday spending season, how do you think consumer confidence will be affected by these elections?
Siegel: Well, I think that we had seen a bounce upward in consumer sentiment, as a result of the gasoline price decline — the natural gas price decline. I think people on the whole, especially those people who are going to use gas, are going to be very pleasantly surprised by their heating bills being lower than they were a year ago, gasoline being also on the low side.
With the stock markets being up and interest rates staying down, this makes for a good holiday season. Some of the fears that the collapse of the housing sector was going to really negatively affect the economy have really dissipated, and rightly so. So, at least at this point, early on, most of the analysts are calling for a fairly robust holiday season.