Third year of Obama should bring stock market gains

President Obama needs to make some sort of compromise with Republicans on tax cuts, and most of all, not enact an overall restrictive fiscal policy, in order to avoid being the first American President to have the stock market fall in the key third year of his first term since Herbert Hoover, investors and strategists said.

From Franklin D. Roosevelt to George W. Bush, the stock market managed a minimum of double digit returns in the third year of their Presidency, according to data gathered by Strategas Research Partners. President Hoover saw the market drop 47 percent. The third year of the Presidential tenure is usually the best of the four as the bold Commander in Chief, dealing with a typical mid-term election brushback, is forced to enact some sort of bipartisan policy or just stands his ground and benefits from the market-friendly environment of a deficit-freezing gridlock.

What’s different with our current President’s situation is that refusing to compromise would mean tax cuts on income, capital gains, dividends and estates would expire, amounting to essentially a tax raise. The Obama administration has offered to extend those Bush tax cuts for everyone except for the wealthiest 3 percent of Americans.

"We have long assumed that Congress and the president would allow the reduced marginal rates for the upper two income brackets, the 15 percent top marginal rate that now applies to dividends and capital gains, and the one-year repeal of the estate tax to expire on schedule," said Goldman Sachs economist Ed McKelvey, in a cautious outlook note to clients on Friday. "Even under these assumptions, which involve extending most of the expiring tax cuts, we reckon that the consolidated fiscal stance is swinging from a net stimulus of 1.3 percentage points to annualized real GDP growth during the second half of 2009 and the first quarter of 2010 to a net drag averaging 1.7 points during 2011."

Obama more than tripled the 8 percent average return that occurs in the first year of the Presidential cycle, but the gains have stalled as his stimulative policies have taken hold. The S&P 500 is little changed in 2010, swinging from gains to losses on each monetary or fiscal policy whim. The Federal Reserve will release its statement on the economy and interest rate policy Tuesday.

"Almost regardless of who was in office, the market would have bounced back from an extremely oversold condition that occurred during the height of panic and fear," said Stephen Weiss of Short Hills Capital. "It’s fair to judge Obama based on his own metrics and his basis for the stimulus package was driving unemployment under 8.5 percent. That didn’t happen. Obama stands a decent chance of being the next Hoover."

One could argue argue that the stock market rose in confident anticipation of his credit crisis response and stimulative policies, and now is just taking a natural bull market pause that takes place after such extreme gains. The President recently proposed another $50 billion in spending on infrastructure and several tax inducements for business that have been received fairly well by the investment community.

"To me, by far, the single most important Obama action was Treasury Secretary Geithner’s stress test," said Karen Finerman, president of hedge fund Metropolitan Capital Advisors. "Unlike prior administrations who had no clear plan, the stress test laid out a comprehensive plan to secure the banks. This allowed some confidence to return to the market and in fact, allowed private capital to bail out the banks."

Indeed financials, led by shares of Bank of America, have been among the best performers under Obama’s tenure. The S&P 500 financials as a group have returned more than 50 percent since he was inaugurated. Still, many of the investors that supported Obama’s previous actions have joined the majority of the country now in believing a bigger compromise is in order on the tax cuts.

A CNBC Poll by Public Opinion Strategies/Hart Research conducted from Sept. 9-12 showed that 55 percent of Americans believe increasing taxes on anyone will slow the economy and kill jobs.

"Tax policy will have to be addressed given the expiring Bush tax cuts and just kicking the can down the road is unlikely to engender confidence," said Tobias Levkovich, Citigroup’s chief U.S. equity strategist. "Furthermore, raising taxes on the rich is a populist approach, but a back of the envelope calculation argues that should the government tax the top five percent of wealthly Americans 100 percent of their income, the government would still be running a deficit by 2050, even if those Americans were willing to work as hard without any personal incentive."

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