The panel of economists and strategists discussed the implications of the recent midterm elections where Republicans took control of the House. They agreed that extending Bush-era tax cuts would be one of the few measures to pass a divided Congress, while gridlock would likely stall other policy changes. The panel also predicted modest economic growth and low interest rates in the coming years.

1. market commentary november 2010
Perspectives
on the Markets:
What the 2010 Midterms Mean for Investors
summary in brief
Two days after the Republican Party took control of
the House of Representatives, a panel of top economists
and strategists gathered to discuss the significance of
the midterm elections and what investors can likely
expect from Washington over the next few years.
The panel was moderated by Charlie Rose,
executive editor and anchor of CHARLIE ROSE.
The participants included Jeff Applegate, chief
investment officer of Morgan Stanley Smith Barney;
Thomas D. Gallagher, a principal at The Scowcroft
Group; Richard Berner, chief US economist at
Morgan Stanley; and Milton Ezrati, the senior
economist and market strategist for Lord Abbett.
Election observers expect to see
tax cuts extended with gridlock
likely in other areas.
The participants agreed that putting the election
behind us is a good thing. “People are strug-
gling with a whole list of concerns including the
economy, the regulatory environment and the
outlook for taxes,” noted Ezrati. He added, “Now
that the election is behind us, that’s one variable
off the list. People got a little break from the
seemingly endless flow of uncertainty.”
Leading experts discuss the significance of the elections.

2. Taxes and the Policy Outlook.
The panelists agree that Bush-era tax
cuts appear likely to be extended for at
least one year and possibly two years.
President Obama’s statement, soon
after the election was over, that he is
willing to work with Congress on the
issuesupportsthisview.“Thelastthing
you want to do for the economy or the
markets or jobs and profit growth,” said
Applegate, “is to have taxes go up.”
Extending the tax cuts may be one of
thefewmeasuresinvestorscanexpectto
come out of Washington, since gridlock
willbethewatchwordinadividedCon-
gress. “Republicans don’t have a strong
incentive to change policy,” explained
Gallagher, adding, “They want to keep
the tea party movement energized and
get in position for 2012.” He added that
changes to entitlement programs are
the key to bringing down spending in
the long term and that neither party
is anxious to tackle this controversial
area right now.
Asked what advice he would offer
President Obama at this stage, Berner
said he would recommend “policies
where you get the most bang for the
buck,”suchas speedingthewrite-down
of debt and mandating a payroll tax
holiday. Berner noted that the payroll
tax holiday might also give employers
an incentive to hire new workers.
Housing. Gridlock in the Capitol
does not bode well for areas of the
economy,likehousing,thatthepanelists
believe need policy solutions. “One in
four homeowners has a mortgage that
is under water,” Berner explained, “and
the shadow inventory of homes that
have yet to be foreclosed on is weighing
on the market.” Berner thinks housing
pricescoulddeclineanother5%to10%.
Furthermore, he believes a meaning-
ful recovery will require policies that
encourage mortgage holders and their
lenders to work together.
StockPricesandInterestRates.
History tells us that next year may be a
goodonefortheUSstockmarket,accord-
ing to Gallagher. The 12-month periods
starting on September 30 of midterm
electionyearshavetypicallybeenstrong,
withstockgainsaveraging25%since1950.
BernerandApplegateagreedthatthe
outlookisalsoverypositiveforemerging
markets.Forexample,Asianeconomies
are forecast to grow by 8% to 9% in
the coming years, and this growth is
increasinglyfueledbydomesticdemand
rather than exports.
Interest rates will not increase until
economic growth and inflation begin to
rise.Bernerforecaststhatlong-termrates
will continue to decline somewhat fur-
ther, with the yield on 10-year Treasury
bondsdroppingto2.0to2.25%.Turning
to specific investment opportunities,
Applegate said: “If we’ve got it right
that the economy is in the process of
recoveryandfiscalproblemsatthestate
and local level will be of less concern
overtime,thenmunicipalbondsshould
be a pretty good opportunity.”
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