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On Jan. 25, 2011, President Barack Obama delivered the annual State of the Union address. The tone of the speech—and the overall feel of the event itself—reflected some significant changes from years past. Much of the president’s softer approach likely can be attributed to the shift of power in the House of Representatives to the Republicans, the result of last November’s election. The president certainly struck a balance, keeping his rhetoric more middle-of-the-road than conservative or liberal.

That softer approach was also reflected in the fact that many members of Congress actually crossed party lines to sit together, rather than remaining on opposite sides of the aisle. This change, along with some refreshing and unexpected, albeit vague, proposals announced by the president, seemed to create a sense of renewed willingness among Congressional members to work together. And if that happens, it could impact the financial markets.

What might we expect in the coming days and months?

The president’s emphasis on the need for greater fiscal responsibility from the federal government, coupled with a goal of deficit reduction and a more pro-business stance, could lead to the greatest potential impact on both equity and fixed income markets.

Equity markets. If we had to point the needle in one direction, we would say most of the initiatives discussed in the State of the Union address should be viewed as positives for equity markets. It appears that the loss of Democratic control in the House, as well as fresh faces on the president’s economic council, have certainly gained his attention. The result is a more accommodative, pro-business central government that understands the country’s need to regain its global competitive advantage and recognizes that, to get there, the U.S. needs to grow its economy and become more of a producer and an innovator, not just a consumer.

Incentives for increased research and development for corporate America, as well as a reduction in the corporate tax rate—one of the highest in the developed world—could impact the markets. The rationale behind these initiatives is to drive both economic and job growth in the U.S. While a drop in tax rates could be immediately beneficial for corporate earnings, it is unclear whether any proposed programs will in fact be successful. The potential for trickle-down growth is there, but it will eventually boil down to what makes it into the final bill.

Fixed income markets. The impact of the president’s speech on the debt markets may be a little harder to read in the short term. The State of the Union address, the Federal Open Market Committee (FOMC) announcement on interest rates, and the World Economic Forum in Davos, Switzerland, all happened to occur in the same week, and they all could influence the market.

Treasuries rallied before and after the president’s address, largely due to a well-received 2-year auction, the strongest in the last 10 auctions, as well as the president’s comments about putting a freeze on spending. Capping the deficit is a popular topic these days, and the fixed income markets responded positively to the news. A reduction in the deficit also has the potential to make Treasuries more attractive not only domestically but also internationally, as China and Japan, for example, may be more prone to purchase Treasuries backed by a fiscally responsible government. On the other hand, it could have a negative impact on the eurozone, as investors seeking minimal risk may be more likely to return to a U.S. dollar-denominated Treasury instead of investing in countries that are at risk of default (i.e., Spain, Portugal, Italy).

Another market-mover, the FOMC announcement on the afternoon of January 26 actually reversed the previous day’s rally, as policymakers decided to keep interest rates low for an extended period. The Fed stated that while it continued to see some improvement in economic conditions, job and real estate markets remained depressed. In addition, the quantitative easing program—through which the Fed is purchasing Treasuries in an effort to stimulate growth—is likely to reach its $600 billion limit, which could contribute to ongoing volatility in the fixed income markets.

The third potential market-mover, the World Economic Forum, also kicked off on January 26. This annual event brings together business and political leaders from around the world. This year, topics will include issues like world trade, currency rates, government debt, and inflation. Investors will be watching closely for information regarding the economic health of the global economy.

Because the president’s State of the Union address provided little actual detail as to how the various initiatives will be accomplished, it’s still too early to tell how the markets will ultimately respond. But if the president is able to take steps to curb spending and reduce the deficit, while increasing investment in research and development, it could add up to a positive environment for the equity and fixed income markets—and for investors.

Allen Insurance and Financial offers Securities and Advisory Services through Commonwealth Financial Network®, the firm ranked “Highest in Independent Advisor Satisfaction among Financial Investment Firms” by J.D. Power and Associates.

This was authored by Jim McAllister and Fred DeBaets, senior research analysts at Commonwealth Financial Network. © 2011 Commonwealth Financial Network®

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