Wheels within wheels in Washington

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Richard Baker: a critic of Fannie and Freddie

It's still legal for investors in US markets to make a buck by trading on inside information but the Securities&Exchange Commission certainly made the technique quite a bit harder when it adopted Regulation Fair Disclosure in 2000.
No longer can public companies curry favour with elite analysts on Wall Street by tipping them off to market-moving news before anybody else sees it. The old way of talking to the markets is out.
But one throwback is alive and well on the banks of the Potomac, where a combination of political adroitness and financial savvy can reap rewards thanks to informed speculation emanating from goings-on in Congress and elsewhere, according to Charles Gabriel, Jr of Prudential Securities. As a 19-year practitioner of the black art of Washington-based political risk forecasting and analysis, Gabriel knows what he's talking about.
The core principles are simple enough. There is an enormous disconnect between the world of investing and the world of US politics. That spells opportunity. "Wall Street is risk averse and sees political and regulatory developments through unrefracted lenses," says Gabriel. "Officials are obtuse and predictably unpredictable. And the media is sensationalist and uninhibited by any requirement to present accurate context."

Putting these pieces together doesn't come naturally to people brought up on the financial side. Life in the world of money and the bottom line can be straightforward by comparison.
Companies boast of having a productive year when they meet or exceed their targets for profits or growth. But politicians are a more devious lot.
A congressman, for example, might introduce a threatening bill with much fanfare and rhetoric but actually enacting new law may not be part of his agenda. The ruse is commonplace.
A case in point is a dozen congressional hearings in 18 months that generated lots of press coverage for the notion of reining in Fannie Mae and Freddie Mac. Fannie and Freddie at one point even signed a voluntary agreement to raise more capital and to submit to new methods of risk disclosure. The commotion drove investors to distraction: a spectacularly successful result by Washington standards, even though there was almost no chance from the beginning of passing any legislation.
"Investors almost always overreact to political risk and the related headline risk," says Gabriel, "often generating excessive disdain for companies reflected in lower share prices and P/E multiples."
He adds that this creates selling opportunities for those perceptive enough to anticipate these before they happen. "It also presents buying opportunities for those with the foresight, stomach and diligence to gauge underlying political risk and to bet that the gap between perception and reality will close within a reasonable time frame," he says.
Gabriel thinks that one of the most deplorable trends in recent years is that interest groups, officials and hardball lobbyists have come to understand the leverage that can be gained by putting a company or industry in play, politically speaking.
"Advocates of perfectly laudable causes have been using ignoble tactics to villainize widely owned American companies through orchestrated, negative PR campaigns," he continues. "Such scorched-earth shakedowns are brutal and, in my view, innocent shareholders can get hurt."
But noise from Washington isn't always enough to move share prices. That usually takes some sort of confluence. The first major tax relief in 20 years - last June - was the product of a new administration, single-party government, unsustainable surpluses, recession, and a shift in committee chairmanships in the US House of Representatives. The mix this year is different, of course.
And the key influences will be: divided government leading up to the November election, unsustainable deficits, last year's shift in control of the Senate, shifts in committee chairmanships, recession and war.
Gabriel's stock picks, like US politicians, come in two flavours: Democrat and Republican. Here are 10 to watch:
Democrat
Fannie Mae and Freddie Mac would gain if Democrats regained control of the House because Republican representative Richard Baker would be dethroned from his perch as chairman of the House capital markets subcommittee. Baker has been a leading critic of Fannie and Freddie.
Merck, Eli Lilly, Bristol Myers and Shering Plough would suffer from Gebhardt shock with a victory by Democrats. The acolytes of present House minority leader Richard A Gebhardt would take advantage of their first opportunity in eight years to control committee agendas and floor time to try to force debate on a prescription drug benefit for retirees.
Healthcare stocks such as Aetna and Cigna would also take a tumble following a win by the Democrats, particularly if the Democrats can force passage of Patient's Bill of Rights legislation.
Republican
Duke Energy and Dynegy might benefit from improved prospects for energy legislation if Republicans can keep control of the House and regain the Senate. The proposed law would reduce capital costs for electric utilities and pipelines by accelerating depreciation charges. Firmer demand and energy prices as the economy recovers also look like a plus.
GM and Ford would stand to gain from a Republican-controlled Congress next year as a result of a climate more conducive to bankruptcy reform. Provisions limiting "cram-downs" would be particularly helpful to Detroit and its car loan business.
Merrill Lynch and Goldman Sachs could be winners following a Republican victory. Continued implementation of the Bush tax cuts as well as improved prospects for social security reform as early as 2003, by all accounts, would be good for their stocks.

No. 6: If you don’t give it to me you’ll only lend it to someone else and look where that got us

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Wheels within wheels in Washington

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