Stock market has a close eye on election outcome

Wall Street is keeping a watchful eye on tomorrow's congressional elections.

The investment community is not expecting a major power shift in either the House or Senate which could derail the Reagan administration's legislative coalition. If such a change developed, the market could react strongly to fears that a much stronger Democratic contingent might push up spending on social programs and federally funded jobs. Some investors think such a political shift would ignite inflationary fires and lower security values.

The Street also fears that voters may ask for a major change of course, and that this could increase legislative efforts to curb the independence of the Federal Reserve System, whose policies are aimed at dampening inflation at the expense of higher unemployment.

''We are not expecting a radical change in the Senate,'' says Julie Sedky, vice-president of Washington Analysis Corporation, a firm that analyzes investment-related issues in the capital. ''And we are not expecting the Republicans to have a loss of more than 25 seats in the House.'' The range of likely Republican losses in the House is 15 to 50 seats, argues James Balog, director of research at Drexel Burnham Lambert Inc. If the Republican Party takes a 50-seat loss in the House, it could also lose control of the Senate, where it now has a 54-to-46 edge, he reckons. ''My guess is that it will come in at the low end of the range. Anything up to 25 won't be serious'' in terms of radically altering the investment climate.

One reason investors are not more worried about upheaval in economic policy is that newly elected legislators are in many cases expected to be ideologically similar to those they defeat.

''Those running for office, and likely to unseat incumbents, are not too much different in political and economic philosophy from the incumbents,'' contends Marshall B. Front, a partner in Stein Roe & Farnham, a Chicago-based firm that manages $7 billion in client accounts and mutual funds. He expects Republican losses in the House to be in the 25-seat range.

And potential policy changes will be inhibited by financial constraints. ''Fears of policy reversals are greater than reality, regardless of the election outcome, because policy options are limited by large deficits,'' Greg A. Smith, the E. F. Hutton & Co. research director, wrote clients Oct 22. (Mr. Smith has since joined Prudential-Bache Securities.)

Some observers are more concerned than others. ''A certain sense of unease has crept into the market,'' says Monte Gordon, research director at the Dreyfus Corporation, a mutual fund manager. ''There is a growing sense that the Republicans may lose 30 to 40 seats in the House. What is at risk here is the President's ability to hold his coalition together.'' Analysts said election-related uncertainty was one reason for the lower volume the market posted last Thursday.

Investment experts are aware that election forecasting is a difficult game, since many voters do not make up their minds until they go to the polls.

''We are cautioning everyone that if this election is typical of recent ones, about one-third of those who vote on Tuesday will not have made up their minds'' beforehand, says Ms. Sedky at Washington Analysis.

And while Wall Street does not anticipate major policy shifts, investors do see the next session of Congress giving greater attention to job creation and stimulation of the economy.

''The recession has gone on a long time. I think there probably will be a modest change in sentiment toward more encouragement of the economy and less of a fight against inflation,'' says Frank Parrish, senior vice-president of Fidelity Management Trust Company in Boston. But he notes that Congress is already ''moving in that direction.''

Although brokers and money managers are discounting the possibility of major changes in the makeup of Congress, they have scenarios that predict what would happen if the Democratic majority in the House were vastly expanded or if the Republicans lost control of the Senate.

In such a case, the expectation is that the Democrats would try to reduce the budget deficit by cutting defense. At the same time, funds would be plowed into welfare and other social programs. ''And they would try to get the Fed to force interest rates down (further), which would lay the basis for rekindling of inflation,'' says Dreyfus's Mr. Gordon.

A major Democratic victory probably would ''signal bigger defense cuts and some tax increases,'' Ms. Sedky says. While brokers may oppose such a course personally, ''there are many on Wall Street who think that wouldn't be bad'' for the economy, she says.