Highlights - The stock market has priced in a close election. As the race has tightened over the past month, the market has slipped lower while Republican-favored industries have outperformed Democrat-favored industries.
- While much attention has been focused on the White House, the dwindling prospects for Republicans in the Senate may have limited the outperformance by Republican-favored industries in recent weeks and helped contribute to the modest pullback in the overall market.
How Wall Street Is Voting The outcome of the elections will define the political context and leadership for policies that address the looming fiscal imbalances coming to a head in early 2013. Last week, we explored the post-election environment and what it could mean for the markets and economy. This week, we will take a look at what the market is pricing in regarding the election outcome. In short, the stock market has priced in a close election compared with where it was a month ago ahead of the debates. As the race has tightened over the past month, the market has slipped lower while Republican-favored industries have outperformed Democrat-favored industries. While there are many "man on the street" polls, what matters most to investors is what is priced in on Wall Street rather than what people are saying on Main Street. Rather than merely looking at the direction of the overall market, our "Wall Street" Election Poll analyzes the market by the industries most likely to be impacted one way or another by the election outcome and can provide insight into what the market is pricing in regarding the election. Based upon these legislation-sensitive industries, we created two indexes early this year to help us track the market's implied forecast of the election outcome reflected in the performance of these industries. Each index was composed of an equal weighting among eight industries that combine to include over 100 large U.S. company stocks. To track what the market has priced in for the Democrats' odds of retaining the White House and Senate, we divided the Democrats index by the Republicans index. While other factors may influence the relative performance of these indexes on a daily or even weekly basis, over time, the election consequences have become paramount as investors increasingly vote with their money. As you can see in Figure 1, an upward sloping line for much of the year (particularly after the Supreme Court upheld the Affordable Care Act in June) suggested the market was pricing in a rising likelihood of the Democrats retaining the White House and their majority in the Senate. The downward sloping line, since the time of the first debate on October 3, suggests improving prospects for the Republicans as the election nears. As the results from the election become known this week, the market may continue or reverse the industry moves tracked in our "Wall Street" Election Poll, depending on the outcome. 
Republican-Favored Industries
S&P 500 Coal & Consumable Fuels/Electric Utilities - Mentioned several times by Governor Romney in the debates, a GOP win could benefit coal producers with more favorable Environmental Protection Agency (EPA) regulations.We could see lower regulatory costs for users of coal such as utilities. S&P 500 Managed Care - Health care is the biggest driver of the long-term budget problems at the Federal level, and states are already cutting Medicaid to balance their budgets.A sweeping win for the GOP may benefit managed care providers as regulatory risks ease and investors increase the odds for a repeal of all or part of the Affordable Care Act (ACA) and lift the HMO tax. S&P 500 Diversified Financial Services - We may see a relief rally among the banks in the legislation-sensitive Diversified Financial Services industry. If the GOP takes the Senate it will result in the change of chairmanships of key committees. While major changes to the financial reform law, Dodd-Frank, are unlikely, an all-GOP Congress might influence regulations implementing the law. S&P 500 Exploration & Production/Drilling - Companies in the energy sector may be impacted by a strong election for the GOP through increased permits and more favorable regulations. S&P 500 Specialty Retail - The specialty retailers could benefit from less risk of tax hikes on higher end consumers.
S&P 500 Telecommunications Services-The potential extension of Bush tax cuts would mean the dividend tax rate may remain closer to 15% instead of going to 43.4%, a plus for companies with lots of cash to distribute. High dividend-paying sectors such as Telecommunications Servicesmay benefit.
Democrat-Favored Industries
S&P 500 Health Care Services/Facilities/Life Sciences Tools & Services - Diagnostic labs, generic drug makers, hospitals, and nursing homes may benefit if the ACA is upheld and from Democrats' leadership, given expanded health care coverage and an emphasis on preventative careand legislation to speed up the introduction of generic drugs to market. S&P 500 Homebuilding/Construction Materials - Democrats may also provide more housing support programs benefitting homebuilders and construction materials providers. S&P 500 Food and Staples Retailing-Some food and staples retailers may benefit from the potential for a further extension of unemployment benefits. S&P 500 Gas Utilities - Users of natural gas may see a relative benefit from stricter coal regulations under the Democrats.S&P 500 Construction & Farm Machinery - Infrastructure spending may fare better under the Democrats, given the relative emphasis on raising tax revenue compared with Republicans' focus on spending cuts. Most polls reflect a tight race for the White House as Governor Romney's odds have improved relative to those of President Obama since the first debate. However, we can see that the likelihood that the Senate may stay in the hands of the Democrats has risen with Republicans appearing less likely to pick up the four seats necessary for control. An easier way to see this, rather than looking at many individual state polls, is to observe the pricing of the futures contracts for Democrats retaining the Senate on the online betting website Intrade.com. As you can see in Figure 3, the odds the Democrats fare well in the Senate races have fully recovered after the debates that marked a turning point for President Obama. As we have noted in the past, the outcome of the Senate is of key importance in this election. The Republicans are very likely to retain control the House, and increasingly, it appears the Democrats may retain control of the Senate. Markets may fear another two years of a divided Congress. A Congress that can act promptly, get bills to a vote on the floor, work on them in conference between the chambers, and bring them swiftly to the president's desk would be a dramatic and welcome change to the last two years of gridlocked government. After all, Congress writes the laws. A Congress that is able to work together is critical after what happened with last year's debt ceiling debacle and debt downgrade of the United States by Standard & Poor's. This matters a lot to investors because the 2013 budget is going to have the biggest impact of any budget in decades. The fiscal headwind composed of tax increases and spending cuts already in the law is likely to result in a recession and bear market for stocks if no action is taken. Congress has important decisions to make, and the stakes are very high. The dwindling prospects for Republicans in the Senate may have limited the outperformance by Republican-favored industries in recent weeks and helped contribute to the modest pullback in the overall market. 
The hard-fought election will likely be followed by more fighting in Congress, resulting in higher volatility and a potential pullback for the stock market. A mildly defensive posture may benefit investors heading into the final months of the year, as markets may provide attractive buying opportunities. IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Consumer Discretionary Sector: Companies that tend to be the most sensitive to economic cycles. Its manufacturing segment includes automotive, household durable goods, textiles and apparel, and leisure equipment. The service segment includes hotels, restaurants and other leisure facilities, media production and services, consumer retailing and services and education services. Consumer Staples Sector: Companies whose businesses are less sensitive to economic cycles. It includes manufacturers and distributors of food, beverages and tobacco, and producers of non-durable household goods and personal products. It also includes food and drug retailing companies. Energy Sector: Companies whose businesses are dominated by either of the following activities: The construction or provision of oil rigs, drilling equipment and other energy-related service and equipment, including seismic data collection. The exploration, production, marketing, refining and/or transportation of oil and gas products, coal and consumable fuels. Financials Sector: Companies involved in activities such as banking, consumer finance, investment banking and brokerage, asset management, insurance and investment, and real estate, including REITs. Health Care Sector: Companies are in two main industry groups-Health Care equipment and supplies or companies that provide health care-related services, including distributors of health care products, providers of basic health care services, and owners and operators of health care facilities and organizations. Companies primarily involved in the research, development, production, and marketing of pharmaceuticals and biotechnology products. Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering and building products, electrical equipment and industrial machinery. Provide commercial services and supplies, including printing, employment, environmental and office services. Provide transportation services, including airlines, couriers, marine, road and rail, and transportation infrastructure. Manufacturing Sector: Companies engaged in chemical, mechanical, or physical transformation of materials, substances, or components into consumer or industrial goods. Materials Sector: Companies that are engaged in a wide range of commodity-related manufacturing. Included in this sector are companies that manufacture chemicals, construction materials, glass, paper, forest products and related packaging products, metals, minerals and mining companies, including producers of steel. Technology Software & Services Sector: Companies include those that primarily develop software in various fields such as the Internet, applications, systems and/or database management and companies that provide information technology consulting and services; technology hardware & Equipment, including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, and semiconductor equipment and products. Telecommunications Services Sector: Companies that provide communications services primarily through a fixed line, cellular, wireless, high bandwidth and/or fiber-optic cable network. Utilities Sector: Companies considered electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power. This publication is not an endorsement for either presidential candidate or party nor does it reflect the political views of LPL Financial. This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. Tracking #1-115226 Exp. 11/13 | 
