Election and QE2 Could Be Catalysts for a Stock Market Reversal

Two days, two potentially huge market-moving events. The election on Tuesday is likely to produce big Republican gains in Congress. Whether that occurs and whether stocks react favorably remains to be seen.

Big is in the eye of the beholder. As noted in a recent post, an overwhelming majority of institutional investors expect the Republicans to take control of the House. That could make it a sell-the-news development - if it happens.

The stock market is likely to rally on Wednesday only if the Republicans make a clean sweep, wresting control of both the Senate and House. There could be a sell-off if they gain a majority in the House alone, and if they fail to do even that, the market could plunge.

The other big news item anticipated this week is the disclosure on Wednesday of details of Federal Reserve purchases of Treasury bonds to try to stimulate the economy. The information about the second round of quantitative easing, or QE2, is expected to be released, with or without crystal clarity, in the statement after the regular meeting of the Fed body that sets interest rate policy.

It's hard to know what to make of this one. The recent strong rally in stocks has been attributed as much to high hopes for the success of QE2 as to expectations for a strong Republican showing in the election, so there could be a sell-the-news reaction here, too, a development that some consider a strong prospect.

But there is also widespread skepticism about just how much QE2 can accomplish - QE1 obviously failed to do the trick over the last two years - as well as anxiety about the long-term effects of the program on inflation and/or the fiscal deficit. The potential consequences of QE2 figured in some of the nightmare scenarios for the economy that top investment advisors suggested to MoneyWatch.

Their concerns are more hypothetical than actual, however - they were asked to speculate about what could happen, not what they expect to happen - and the recognition on Wall Street that something could go wrong with QE2 in the distant future seems to be trumped by faith in its ability to work wonders in the here and now.

Some strategists have warned of the possibility of a sell-the-news dip in the stock market this week, which could lessen the likelihood that it will happen. Still, taking everything into consideration, there's a good chance that stocks will react to the election and the Fed meeting by giving back some of their recent gains.