Institutional investors fear a government policy mistake far more than inflation, terrorism, a housing double dip, a weak dollar, poor earnings or any other potential risk to the economy, according to a survey of 100 mutual fund, hedge fund and pension fund managers by Citigroup Global Markets.

“Government Policy Missteps” garnered more than a third of the participants’ votes as their biggest fears in the quarterly survey, ahead of the more than 15 percent who cited “Protectionism,” which is also strongly-tied to the actions of the Administration and Congress.

But these very same investors are bullish on the market and plan to buy stocks this quarter because they believe the chances of that policy error will decrease if Republicans take back the House of Representatives in November.

“While political polls suggest that changes are likely in Washington, a staggering number of professional investors think that the Republicans will win back the House of Representatives in November and that may be adding to their sense of a better business environment going forward,” said Tobias Levkovich, Citigroup’s U.S. equity strategist, in a note.

Investors, on average, see the S&P 500 adding at least another 3 percent to 1204 by the end of the year, according to the survey, up from their July mean projection of 1138. More than 70 percent expect to put more money to work in equities this quarter and next year. The S&P 500 is up 14 percent from its 2010 closing low hit on July 2.

“If you overlay the 2004 stock market chart during those elections, it gets you to between 1200 and 1300 on the S&P 500 before the end of this year,” said Stuart Frankel’s Steve Grasso, whose clients have been placing more orders with him in anticipation of a political change.

In 2004, stocks rallied 13 percent from their early August lows. George W. Bush won a second term as President and Republicans gained seats in both houses.

With corn prices and oil prices jumping and Federal Reserve Chairman Ben Bernanke ready to print more money, one would think inflation would get more votes. But that fear came in as the biggest worry for a paltry 5 percent of investors. So just what will happen to ease investors’ biggest fear if Republicans take back the House and gain seats in the Senate?

Given the expiration of tax cuts and spending programs at the end of this year, this November and December could be a more active post-election legislative session than we’ve seen in years, according to Jason Trennert and his team at Strategas Research Partners. Republicans may see more Democrats cross over to their side of the aisle and support them in at least a one-year extension of the Bush tax cuts for all.

“In recent weeks, we began to pick up that more and more Democrats in the Senate were seeking to extend all of the tax cuts, not just the middle class tax cuts,” stated the note. Many of these members up for re-election in 2012 “do not want tax rates going higher now and hurting the economy ahead of their election. Therefore the ability to get 60 votes for just the middle class tax cuts in the Senate will remain difficult.”

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Trader disclosure: On Oct.11, 2010, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders; Adami owns (AGU), (BTU), (NUE), (C), (GS), (INTC), (MSFT); Adami’s wife works at Merck; Seymour owns (AAPL), (GE), (GOOG), (INTC), (MON), (MSFT), (MOS), (POT); Pete Najarian owns (DD); Pete Najarian owns (GE); Pete Najarian owns (POT); Pete Najarian owns (BEXP) calls; Pete Najarian owns (BP) calls; Pete Najarian owns (BME) calls; Pete Najarian owns (ERTS) calls; Pete Najarian owns (GDXJ); Pete Najarian owns (BRCD); Pete Najarian owns (CNI); Grasso owns (ASTM), (BA), (BAC), (C), (CSCO), (JPM), (LPX), (MO), (MOT), (NDAQ), (PFE), (PRST)

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