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THE CLEAR WINNER IN THE Scott Brown's victory in the Massachusetts special senatorial election is gridlock.
And as far as financial markets are concerned, gridlock is good. That's what the Dow Jones Industrial Average's 116-point, 1.1% gain Tuesday showed as polls indicated the Republican challenger winning the late Ted Kennedy's seat.
While widely viewed as a referendum on health-care legislation, the Obama administration's top domestic priority, there is another possible inference to be drawn from the GOP win in Massachusetts.
It is just one more instance of voters' disgust with the status quo. The same "throw-the-bums-out" attitude that swept Barack Obama and the Democrats to their historic victory produced upset wins of Republicans in gubernatorial races last November in New Jersey. Now, that anti-incumbent spirit has produced the first Republican Senator in Massachusetts in three decades.
That, if anything, is more likely to curb the main legislative initiatives of the Obama Administration as it will lack a filibuster-proof, 60-seat majority in the Senate. In other words, gridlock.
Arguably, gridlock arrived even before Brown's defeat of Democrat Martha Coakley. Despite huge majorities, Democrats still haven't been able to forge an agreement in the conference committee that's been working for weeks to reconcile differences between the House and Senate reform bills.
"I've been rooting for gridlock. It's good for the country, and it's bullish for stocks," Ed Yardeni, the head of the eponymously named Yardeni Research wrote in a research note Tuesday morning.
But, as ISI's Washington team of Tom Gallagher, Andy Laperriere and Melissa Loesberg wrote to clients Tuesday, whether gridlock is good or bad for stocks "all depends on which is greater, the markets' need or fear of Washington action. On health care and climate change, the market probably prefers gridlock.
"On tax rates, gridlock would mean tax hikes for all income taxpayers," they continue. "Markets may anticipate a more favorable outcome for upper-income taxpayers. That's plausible, but it would be a leap to draw that conclusion from an election that was essentially a referendum on health care.
"Another area where gridlock would not be market-friendly is in deficit reduction, but that seems to be something further out on the horizon for the financial markets," ISI's Washington team concludes.
But the implications for health-care stocks seem less uncertain.
"In the Nov. 9 Morning Briefing, I recommended overweighting the Health-Care sector," wrote Yardeni. "That was right after Speaker Nancy Pelosi pushed her health-care plan through the House on Nov. 7. I figured that PelosiCare was the worst-case scenario for the health-care industry. So if the ultimate legislation turned out to be less severe, then health-care stocks should outperform. If Gridlock wins [Tuesday], health-care stocks could lead the overall market higher in coming days and weeks."
And so they did Tuesday, gaining about 2% for the group, twice the gain of the broad market.
It still is possible to get a health-care bill passed. One way would be for the House to pass the Senate bill as it stands, in which case it heads straight to the White House for the president's signature. That may be tough, however, given that Brown's victory in Massachusetts may make some Democrats less likely to vote for a health-care bill, according to ISI's team.
As for other sectors, they think a Massachusetts GOP win "would just be an extra nail in the coffin of cap and trade" legislation, although regulatory action on climate change wouldn't be affected. And odds fall for a financial reregulation with Brown's victory.
Tuesday's vote in Massachusetts would augur more Democratic losses in November's House and Senate races. A loss of seats by the incumbent party in mid-term elections is the norm, but the extent will likely be determined by three things: jobs, jobs and jobs.
Voters' anger reflects in large part unemployment and falling wealth. As James Carville rallied the Democrats in 1992 with the cry, "It's the economy, stupid" once more.
But whether the markets will accommodate further expansion of fiscal stimulus with a deficit that already exceeds a trillion dollars is another question. As Carville observed to his chagrin back then, the bond market may hold the real power here.
Comments: randall.forsyth@barrons.com
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