Christian Gattiker, head of research and equity strategy at Julius Baer, looks at the impact of the rejection by the US House of Representatives of Hank Paulson's USD700bn bailout plan.

What happened?

In a stunning upset, the US House of Representatives on Monday rejected the bill that would have framed Treasury Secretary Paulson's financial rescue plan.

A large number of Democrat members joined Republicans in voting the bill down, suggesting perhaps that the Bush administration, Paulson and the House leadership misjudged their chances of success.

The aftermath of the vote saw much partisan finger-pointing, as well as a visibly dismayed Paulson calling for a return to the negotiating table to hammer out a new deal. Importantly, despite the rhetoric, neither Democrats nor Republicans went so far as to close the door on further discussions that would lead to a new bill. In terms of immediate political repercussions, the Iowa Electronic Markets showed Democrats gaining at the expense of Republicans.

Forced sellers to create volatility first, opportunities later

The negative surprise in the political process exacerbates the current distress in the financial space. This is best illustrated by the Ted spread index, which shows risk premiums required for short-term cash lending among banks. The Ted spread was already at record levels before the rejection of the rescue plan and sky-rocketed thereafter.

This indicates further distress as forced sellers - that is, financial players - are likely to reduce positions into an illiquid market.

This is likely to create further volatility and selling pressure in financial assets first, but will create opportunities down the road. In global stock markets, the current sell-off should open new opportunities for corporate buyers.

Non-financial corporates on average are better capitalised than at this stage during previous downswings. Hence a likely pick-up in corporate M&A activity would be supportive for equities.

Stay focused, seek to increase asset quality, look for capital protection

This is not the time to make major portfolio shifts. Highly leveraged players will have to sell into illiquid markets, creating both volatility and downside pressure. Investors should focus on quality, liquidity, funding, and support. Capital preservation remains the ultimate goal in these markets.