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Investors await elections, but Fed may loom larger

After a two-month rally in the stock market, some investors are about to see if they get what they wished for: more Republicans in Congress and lots of cheap money.
/ Source: Reuters

The wait is almost over.

After a two-month rally in the stock market, some investors are about to see if they get what they wished for: more Republicans in Congress and lots of cheap money.

The U.S. stock market has priced in the Republicans gaining ground in Tuesday's midterm elections, an outcome widely seen as more business-friendly, as well as the Federal Reserve pumping billions into the economy through Treasury debt purchases. The Fed's statement on Wednesday afternoon at the end of its two-day policy meeting is widely anticipated for details of the central bank's economic stimulus plan.

Jobs will be a touchstone, with the high U.S. unemployment rate figuring into the campaign rhetoric of Democrats and Republicans alike in the midterm elections. The federal government's non-farm payrolls report, due on Friday, is expected to show a gain of 60,000 jobs in October, compared with September's loss of 95,000 jobs, according to economists polled by Reuters. The U.S. unemployment rate, however, is seen holding steady at 9.6 percent.

More earnings from S&P 500 companies and a steady stream of top-tier economic indicators will give investors more evidence of the economy's health throughout the week.

A series of foreign central bank meetings also is on tap.

But these numbers will serve mostly as backdrop to the outcome of the elections and the Fed meeting.

With so many variables in the week ahead, Wall Street professionals are unusually reticent to call the market,

Only one thing seems for sure: Volatility will play a major role.

Traders expect the week to end with a swing of around 2.5 percent in either direction, based on options activity in the SPDR S&P 500 fund. While that is not out of the ordinary, traders could see significant volatility during the week as events unfold.

"It will probably be a very volatile and very active market because there are a lot of moving parts," said John Praveen, chief investment strategist of Prudential International Investments Advisers LLC in Newark, New Jersey.

Fireworks after Fed?
If there are fireworks, they will probably come after the Fed's two-day meeting. On Wednesday, the meeting will conclude with a statement at 2:15 p.m. EDT, That could create a dead period for markets at the start of the week, especially if the elections' results are in line with predictions.

Expectations of the size of the Fed's purchases of U.S. government bonds have been coming down in recent days. That has kept the stock market locked in a tight range, but it has also opened the door for upside surprises.

"Two weeks ago, the Fed was definitely poised to disappoint the market," said Burt White, managing director and chief investment officer of LPL Financial in Boston. "Now, it's much more balanced, and maybe even leaning toward a slight surprise."

Most leading economists expect the Fed to buy between $80 billion and $100 billion worth of assets per month, according to a recent Reuters poll of primary U.S. Treasury dealers. Estimates for how much the Fed will eventually spend varied widely, from $250 billion to as high as $2 trillion.

The Bank of Japan has moved its policy meeting forward to the end of the week, right after the Fed's meeting. Investors suspect the Japanese central bank — whose board members will meet on Thursday and Friday — may respond by stepping up its bond purchases in reaction to the Fed.

The Bank of England and the European Central Bank are also set to hold policy meetings during the week.

Among the readings on the U.S. economy expected during the week, Wall Street will watch two reports from the Institute for Supply Management. The ISM index on U.S. manufacturing for October, due on Monday, is forecast to dip to 54.0 from September's reading of 54.4, the Reuters poll showed. The ISM services- sector index for October, due on Wednesday, is seen edging up to 53.5 from September's reading of 53.2.

All about the House
Traders on online betting forum InTrade are betting on a more than 90 percent chance of the Republicans winning the House, meaning the degree of the potential victory could be more important than the win itself.

InTrade traders are pricing in a 45 percent chance that Republicans will win more than 60 seats in the 435-seat House — they need to gain 39 seats to control the chamber — and a 55.5 percent chance that they will take the Senate.

A stronger-than-expected Republican showing in the House and a Republican coup in the Senate could be a boost for the stock market. To be sure, some would view the failure to take the House as a blow.

Bernie McSherry, senior vice president of Cuttone & Co, a New York Stock Exchange floor trader, said if exit polls point to a surprising result, then that could filter into markets on the same day.

"You could see some reaction late in the day on Tuesday, but only in the case of a really substantial surprise," he said. "If it proceeds as expected or is too close to call, I think people will hold off until the following day."

Volatility play
Wayne Kaufman, chief market analyst of John Thomas Financial in New York, said his firm is betting stock prices will rise near-term as earnings beat estimates. But his firm will view any sharp pullbacks in stocks as a buying opportunity.

"We are long the market," he said. "We are watching to see if we are going to have signs of distribution, but we are not going to forecast that happening. We will be in a reactive mode, we will respond to what we see."

The CBOE Volatility Index, or VIX, is still relatively low, but it has been picking up steam in the last several days. The index, a popular gauge of investor anxiety, rose 1.5 percent on Friday to close at 21.20.