“Those who make peaceful revolution impossible will make violent revolution inevitable”

– John Fitzgerald Kennedy

As in 1994, when the Republicans took control of the House of Representatives, this past election was a peaceful revolution with opposite results – the Democrats took control of the House and the Senate. During the campaign, there was quite a bit of rhetoric and mudslinging from both sides of the aisle and the tone of politics seems to be getting worse every year. However, no matter what political persuasion you are, we should all be proud of the fact that this country has had two revolutions over the past 12 years without one shot being fired. This is truly a blessing that we should all embrace.

So what will change with the new Congress, we believe not much at all. Although the Democrats control both the House and Senate, you really need 60 votes in the Senate to stop a filibuster. The Democrats don not have that many votes. The next two years will really be a battle for the Presidency in 2008. With a lame duck president and a Congress not wanting to hurt itself, the next two years should consist of little legislative action. Major initiatives such as Social Security reform, tax cuts/increases, and estate tax reform are all dead. The only thing that will change is the rhetoric. As Bill Clinton said, “it’s the economy stupid.” The Democrats will not want to be blamed if the economy goes south. Therefore, they may, as promised, curb government spending on pet projects like “the bridge to nowhere” in Alaska. It is in both party’s interest to see the economy succeed. This should be good for the market.

Because of the stalemate in Washington, the fundamentals of the market will be the driver of returns over the next two years. There are some positives that will propel the market higher over the next two years:

• The stock market is not expensive with the market selling at about 17x earnings.
• The supply of stock continues to drop due to:
  • Company buybacks
  • Increased merger activity
  • Sarbanes/Oxley making it difficult for companies to go public.
• The Federal Reserve will not be raising interest rates anytime soon and may in fact reduce them next year.
• Company earnings are very good.
• Inflation is moderating with expectations dropping considerably due to lower energy prices and weaker final demand.
• During the third year of the presidency, the market tends to do very well (1995, 1999, 2003, and 2007?).

Of course, there are some negative things that could affect the market as well:

• The stock market has had a nice run since August and may have some short term difficulty with:
  • Bullish sentiment among advisers now standing at 60%.
  • % of NYSE stocks above 30-week moving average is now 80% (it was less than 30% in August).
• Global crises – Iran, Venezuela, Iraq, etc.
• A terrorist attack by radical Muslims. (FYI – the #1 name for newborns in Amsterdam in 2006 was Mohammed!!)
• The housing market crumbles more than is expected causing a recession.

We believe that the positives will outweigh the negatives over the next two years. However, the market may suffer a correction in the near term since it is starting to become overbought. For those clients that have balanced accounts or have given us the ability to invest a portion in cash or fixed income, we may be lightening up our equity exposure sometime in January if the market continues to head higher. We see this as a short term rebalancing move in order to capture the most recent gains.

Death of the “Great” economist

The world lost one of the most profound economists of this decade on November 16th with the death of Milton Friedman at age 94. Milton was very instrumental in changing the focus of the economy from a classic demand side model (Keynesian approach) to a supply side economic model. His economic thoughts helped propel the economy out of the doldrums of the 70’s (Nixon, Ford and Carter days) making the 80’s one of the strongest periods ever for the economy. Not only was he a great economist, but he had some memorable quotes. Below is a sample we thought you might appreciate:

“Nothing is so permanent as a temporary government program”

“A society that puts equality ahead of freedom will end up with neither equality or freedom”

“Inflation is taxation without legislation”

“The economy and the stock market are two different things”.