An inherited budget deficit of over $400 billion will tie the hands of whoever is elected president this November.

However, Money Morning’s Martin Hutchinson says a McCain victory would boost defense and Big Pharma stocks. And McCain’s VP choice, Sarah Palin, is a strong advocate of more drilling for oil, which is encouraging for domestic oil stocks.

On the other hand, McCain would likely hold onto Ben Bernanke as Fed chief. This would mean an extended period of low interest rates and painful inflation down the line.

This from Martin:

Either presidential candidate will have to raise taxes.

Democratic candidate Barack Obama will raise them because he wants to (or rather, because he has some “exciting” spending ideas that will require it) and McCain will raise them because he wants to keep the budget within shouting distance of a balanced position.

Although McCain has suggested some tax cuts, on that suggested the elimination of the gas tax during the summer period, that proposal was met with universal derision by economists (because it benefit would go entirely to Saudi Arabia and other oil producers).

Indeed, it suggested that economics was not McCain’s strong suit or greatest interest. In any case, only draconian public spending cuts would save the necessity for substantial tax increases, and those did not seem likely from either candidate.

McCain’s selection of Alaska Gov. Sarah Palin as his running mate late last week, changes the position somewhat.

There in Alaska, Palin has a tough reputation as a fighter against government waste. As McCain’s vice president, Palin would constitutionally have the responsibility to act as president of the Senate.

Is it too much to hope that, whichever party controls Congress, Palin will be at least modestly effective in reducing the orgy of earmarked spending, agricultural subsidies, ethanol subsidies and other wasteful public spending that damages the economy and benefits only a few favored lobbyists?

Lower public spending would allow for modestly lower taxes: McCain has promised to keep dividend and capital gains tax rates at their current levels, and to eliminate the estate tax.

Investors can at least hope that a combination of Palin, Republican fiscal doctrine and McCain’s self interest will push the political system towards modest tax cuts, or at least away from tax increases such as the draconian raises in capital gains or dividend taxes that would damage investors both directly in their pockets and indirectly through declines in stock values.

Palin’s other influence is likely to be in the energy area. McCain has gradually, under huge pressure from his Republican supporters due to high oil prices, been moving from his previous opposition to drilling in the offshore Continental Shelf and Alaska’s Arctic National Wildlife Reserve. Currently, he favors offshore drilling, but not drilling in ANWR.

McCain also favors a very expensive “cap-and-trade” approach to the global warming problem, which involves a new bureaucracy figuring out what each major carbon emitter should be permitted to emit, and allocating permits accordingly, without charge.

Obama’s equivalent scheme, which involves auctioning the permits, has two virtues: It leaves the allocation of permits to the free market rather than a government bureaucracy and it produces revenue for the federal government, which can be used to cut other taxes.

Palin is a breath of fresh air on the whole subject.

She remains unconvinced that mankind has any significant effect on global climate, and like most Alaskans believes that oil drilling in ANWR and elsewhere represents the economic future of her state. How far she will manage to convince McCain of her position is doubtful, but her access to the ticket should mean at least more oil drilling and a less draconian cap-and-trade system than would otherwise be the case.

A further advantage of a McCain presidency could be the conclusion of more trade deals, and the consequent expansion of both world trade and of the economy in general.

McCain is even more of a free trader than President Bush and has more credibility abroad; hence, it must be possible that he could make progress on the Doha Round of trade negotiations. That would be particularly important for the economies of emerging markets, which would be given greater access to the U.S. market, and reap rewards in the form of economic growth and corporate profits.

There are two areas where McCain is worse news for investors and the U.S. economy than Obama.

One is monetary policy. Obama is advised by former “tight money” Federal Reserve Chairman Paul Volcker, and hence understands the inflation-fighting benefits of higher interest rates. He will also want to make a change at the Fed, where the Democrats have not appointed a chairman since Volcker himself in 1979.

Conversely, McCain will be more likely to extend the term of current Fed Chairman Ben S. Bernanke (which expires in January 2010), thereby producing an additional extended period of excessively low interest rates.

While beneficial for the stock market in the short run, low interest rates in the current environment will produce accelerating inflation, which will require a much more seriously damaging period of much higher interest rates to sort out.

Low rates also will accelerate the process of outsourcing U.S. industry to low-wage countries, which do not suffer their normal “cost of capital” disadvantage when global money is cheap.

The other downside is in security policy. McCain is likely to keep troops in Iraq longer than Obama, and is more likely to engage in military operations elsewhere (though under either candidate some step-up in Afghanistan seems probable).

That costs money, increases the budget deficit (or raises taxes) and leads to slower economic growth and higher inflation over the long term.

A McCain presidency would be good for defense stocks, as defense spending would be higher.

It would be good for the large, patented pharmaceutical stocks, as they would not be subjected to price controls as the Democrats currently propose.

It would also be very good for domestic oil companies, which would expand their operations in offshore oil, unconventional oil sources such as shale and possible drilling in ANWR.

It might also be good for “new energy” companies, although it is less clear than with Obama where a McCain/Palin administration might end up on that issue.

P.S. This extract is taken from an ongoing Money Morning series that examines the investor implications of the presidential election campaign.

Source: Election 2008: A McCain Victory Won’t Mean Same Old Republican Story