Nancy Pelosi will almost certainly be our next Speaker of the House. She has made it clear that reining in drug prices will be on the top of her agenda. Specifically, she has promised that within a week of the Democrats taking control of the House, they will pass legislation giving the secretary of health and human services authority to negotiate lower drug prices on behalf of Medicare and other government programs.

That sounds like bad news, but the drug stocks seem to have shrugged off this threat, and have continued to do well. Are investors paying attention?

Andy Laperriere, Washington-based analyst for International Strategy & Investment, thinks the Democrats will win control of the House of Representatives and that they have a shot of taking the Senate. His analysis is convincing; a review of the House seats up for grabs suggests that his official 60% probability assessment is low. He gives odds of 40% that the Senate will go to the Dems, and sees a split Congress as the most likely outcome.

What are the implications for investors? Certainly a divided Congress would mean little in the way of dramatic policy changes before the next presidential election. However, Mr. Laperriere confirms that there is “headline risk” in several areas, which investors have only recently begun to anticipate.

Sorrell Mathes, head of the eponymous money management firm, does see problems ahead for pharmaceutical companies like Pfizer (PFE $27) and Merck (MRK $46). “The Democrats are in favor of generics and possibly the importation of drugs from Canada,” Mr. Mathes says. “Also, the tort lawyers are still out there.” Bottom line? “It’s not worth owning those stocks.”

Like some others, Mr. Mathes imagines the country will enter a period he describes as “blessed gridlock,” with the change in leadership creating more sound waves than actual legislation.

Maybe, but the noise could be damaging. Especially if investors begin to anticipate a Democratic win in 2008. Then the noise becomes more ominous. Mr. Laperriere says that in addition to the large pharmaceutical companies, managed care companies like Humana (HUM $62) and United Healthcare (UNH $49) could also find themselves in the Democrats’ crosshairs. “The Democrats think the government is overcompensating these companies” Mr. Laperriere says, who thinks they will move to cut payments.

What other ills will the Democrats try to address? Wal-Mart-bashing is likely, says Mr. Laperriere. Labor unions will push Congress to give Wal-Mart Stores (WMT $49 ) “tobacco industry-like treatment,” meaning numerous investigatory hearings into the company’s activities. This could cast a pall not only on the stock but also on sales. Consumers may lose confidence in the chain, and seek bargains elsewhere.

Elizabeth Bramwell, who runs a growth stock firm, thinks attacks on Wal-Mart could backfire. “Democrats would be making a big mistake” she says. “The company recently reported that 84% of Americans visited a Wal-Mart store last year. The company is helping bring down drug costs, and raising the standard of living for average Americans.” Though many would agree, the damage that could be done by a full-scale attack on the company could be significant. Labor unions will also push Democrats to agitate for a higher minimum wage, and indeed an increase to $7.25 from $5.15 is on Ms. Pelosi’s “first 100 hours” agenda. Raises in the federal minimum have traditionally been viewed as negative for restaurants and retailers who rely heavily on hourly workers. With numerous states moving to raise local wages, however, the imposition of a higher federal standard may not be so significant.

Two stocks that could benefit from the Democrats’ social agenda are Fannie Mae (FNM $59) and Freddie Mac (FRE $69), according to Mr. Laperriere. The Republicans would like to shrink the portfolios of these two giant mortgage lenders, which would significantly cut into earnings. If the Democrats take control of the House, such legislation is unlikely to pass. In a recent interview with the Financial Times, Barney Frank, who would likely become chairman of the House Financial Services Committee, is quoted as saying that preserving and creating affordable housing will be a high priority. The stocks have been out of favor for a number of reasons, but diminishing political risk may improve their prospects.

What about defense spending? Traditionally the Republicans have been more likely than their opponents to raise defense budgets. And, if the Dems follow through on their demands for a speedy exit from Iraq, surely defense stocks like Raytheon (RTN $50) and Lockheed Martin (LMT $87) might weaken. Mr. Laperriere views the defense issues as relatively safe because America is not currently spending nearly enough to replace our existing stock of armament. Regardless of the Iraq situation, spending will likely drift higher.

Mr. Mathes thinks that a Democratic win would not be good for defense stocks. However, he notes that the Dems are “great believers in whiz-bang gadgetry, which they always prefer to putting boots on the ground.” This preference could bolster electronic defense stocks. Overall, multiples on defense contractors may come under pressure as the buildup for Iraq wanes and as budget considerations reenter the limelight.

Other issues that are bound to arise as the Republicans’ lock on Congress weakens include tax policy, increased regulatory oversight of the financial services industry, trade policy with China, and immigration. The Democrats’ urge to raise taxes will likely refocus on dividends and capital gains, which will not help the market. However, such changes in policy will not likely occur in the near term.

A greater push to regulate hedge funds is almost inevitable, as is a push to further democratize proxy voting. Big business is already viewed with suspicion, and the Democrats can always hope to score points with voters by going after corporate managements. Taking on China will also be popular, though it would likely prove terribly costly to Americans. “Any tariff would be terribly inflationary” Ms. Bramwell says.”You have to assume rational people will prevail.” Would that we could.

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