Never Mind Wall Street, Watch D.C.

These are terrible times for traditional equity research. Research budgets are being cut for many reasons, especially the financial trouble at investment banks, hedge funds and institutional investors. Also, fewer investors take seriously analysts’ earnings or cash flow projections at a time when the economic situation is so volatile and difficult to predict.

However, despite the tough times, smart investors may need to beef up research coverage of one important topic: Washington politics.

World stock markets plunged overnight after the U.S. Senate failed to pass a $14-billion bailout package for the U.S. auto industry, but then U.S. stocks did better Friday, perhaps because the Bush administration said it wouldn’t let the ‘Big Three’ collapse.

It’s only the latest example of how closely investors are watching Washington. The halls of government are the key to the future of not just the auto industry, but the financial sector (which got its own bailout), the health care industry (as reform legislation is developed) and the energy business (as lawmakers discuss the climate change issue). Government stimulus efforts under an Obama administration could also directly influence retailers, construction firms and many other parts of the economy.

Federal policy has always mattered to the markets, but something fundamental has shifted recently. The financial crisis has pushed government toward an aggressive, hands-on approach to the economy.

The Bush administration took the first steps toward government activism with its financial bailout and promises to protect the auto industry. President-Elect Obama and Democrats in Congress will be aggressive, too, in hopes of preventing a deep economic slowdown.

Washington can be a world as complex, incomprehensible and intimidating to outsiders as Wall Street is to novice investors. In the next few years, much depends on not just Obama’s policy preferences, but the vast power wielded by committee chairman like Montana Sen. Max Baucus or House members Barney Frank and Charles Rangel, and even their staffers who do much of the actual writing of legislation.

Gaining insight into this world will be crucial for investors. This news item is evidence at least some firms agree: Glass, Lewis & Co. bought up political and economic advisory firm Washington Analysis Corporation late last month.

Integrity Research Associates, which tracks the research industry, commented on the acquisition:

We expect that insight into upcoming changes in US government policy and legislation, and the impact this will have on businesses, will be among the most in-demand forms of research over the next few years. […] The injection of public funds into financial and other companies will mean that Washington will loom larger in investors’ mindsets than at any time in recent memory.
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