This is normally a quiet week in Washington D.C.; Instead, there is chatter in the Capitol of a surprise post-Labor Day announcement by the Bush Administration. My wild speculation is that as the Congress returns for the Fall session, the President will unveil a set of "targeted investor tax cuts;" A brief look at the “why and when” might provide some insight – and help with portfolio positioning:

After the holiday weekend, there are two looming items on the Administration’s calendar: The Anniversary of the September 11th Tragedy, and about 60 days later, the midterm Congressional Elections.

Presidential handlers are desperate to go into these events with the market showing Green instead of Red.

Whatever hopes the President had for pinned for one final series of interest rate cuts was dashed by this week's Durable Goods number, and from comments by 3 different Fed Governors. (As we have been telling our institutional clients for months, this cycle of Fed cuts is officially over).

Its always dicey to attempt to gauge the actions of Politicians; Its even more speculative to impact how potential political wrangling will impact the markets. Still, the start of the Fall session presents an opportunity to fathom what could happen.

There's little doubt the Administration has “here we go again” nightmares of another cascading waterfall sell-off. They can blame Clinton or Greenspan for inflating the bubble, but the point at which voters hold them responsible for their handling of the post-bubble era is rapidly approaching.

The President missed an opportunity to restore investor confidence by doing more than simply “talking down” the corporate irresponsibility of Enron, Worldcom, etc.; The political quandry for the Bush team was that using anything stronger than the Bully Pulpit might have put W at odds with segments of his support base; Not a good strategy in a tight election year.

Instead, we look for the President to roll out a variety of targeted tax relief options for investors. Any of the following is more consistent with Bush's politics, and might have the short term effect of goosing the Dow: 1) Raising the $3,000/yr capital loss rollover to $5k or even $10k; 2) Doubling the allowable IRA and 401K contributions; 3) Cutting the long term capital gains tax by 25%; 4) Making corporate dividends – now double taxed – partly or completely tax exempt.

Anyone of these scenarios has the potential to roll billions of cash back into the market. Upon the announcement, I would expect a 2- 4% single day rally. If the Congress were to back this, the rally could develop real legs.

Regardless, if the roll out of this “September Surprise” were handled appropriately, it would certainly juice the capital markets. I suspect it could even be the kind of spark that instigates an intermediate term rally -- one that the administration would hope lasts through the November elections.

While the pre-holiday noise from the President and Veep has been on Iraq, given the lack of troop or hardware movements, any attack on Saddam is many months away. The War PR assault makes for good cover for a real surprise; Could targeted investor tax cuts be it?

The timing of this – after Labor Day, but before 9/11 memorials – makes sense to us.

We therefore would not be short heading into the holiday weekend. Use any weakness to cover short positions.

-Barry Ritholtz
August 29, 2002

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