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JUST AS THE POLLS and the pundits predicted, Republicans recovered their majority in the House of Representatives while Democrats' majority in the Senate was trimmed in Tuesday's midterm elections. With President Obama thus weakened, gridlock in government seems assured for the next two years.
The conventional wisdom is that's good for financial markets. And while the historical record supports that belief, in this case, to paraphrase Henry Ford, history is bunk.
No honest or sentient observer would argue that the stock market's 13% rally since late August had much, if anything, to do with discounting Tuesday's election results. Higher prices for risk assets reflect almost entirely the anticipated impact of the Federal Reserve's launch of QE2, the second phase of quantitative easing, expected to total $500 billion, according to consensus estimates. The prospect of that extra liquidity also has driven the dollar down 7%, so monetary policy, not politics, have driven markets. Details of the market's other key decision are due Wednesday afternoon.
If gridlock is regarded fondly by the markets, it may be because stocks have done well during those periods. According to RBC Capital Markets, the Standard & Poor's 500 has returned an average of 2.11% during all-Republican governments, 6.74% during all-Democratic governments and 9.02% during divided governments.
But the dollar did worse under full GOP governments, losing 1.17% per annum while gaining 0.06% under full Democratic governments and rising 0.13% during divided governments.
Finally, gridlock periods saw the strongest growth in real "organic" personal income (excluding transfer payments) and in gross domestic product. Incomes grew 3.07% annually under gridlock—half again better than during Republican and Democratic governments, 2.06% and 1.99%, respectively. GDP growth also expanded 3% annually during gridlock years, versus 2.47% under Democrats and 2.45% under Republicans.
The vastly better economic results under gridlock no doubt reflect the record of the 1990s, which now is best remembered for the tech and telecom bubble. But what's more relevant is the change in tack of the Clinton Administration after the Republican takeover of Congress in 1994.
Clinton backed key conservative, free-market initiatives such as the North American Free Trade Agreement—an important, pro-growth tax cut on trade—and welfare reform. By his 1996 State of the Union, Bill Clinton would declare, "the era of big government is over."
So, what is characterized as gridlock was in fact was a move to the center by the pragmatic Clinton White House to deal with the Republican Congress. But whatever bipartisanship evaporated in the impeachment that would follow. And it has been thus ever since.
Now, gridlock may be better characterized as paralysis. It would mean an inability to deal with the most pressing problems besetting the economy.
Will a House full of freshman GOP firebrands and led by John Boehner of Ohio, the likely future Speaker, get a Democratic Senate to go along with measures to curb the cost of government? Will a GOP House do anything that would close the massive fiscal gap (discussed here yesterday, "Why Americans Are Angry") that involves increasing revenues?
So, before the markets think about celebrating gridlock, think about what that metaphor means. Gridlocked traffic results because of the refusal of drivers in one direction to yield to others going crosswise to them. Nothing can move, not even emergency vehicles, the result of which can be fatal in some instances.
That doesn't sound like a bullish formula.
Comments: E-mail: randall.forsyth@barrons.com
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