Following America’s election, you may be blissful over Biden’s win or terrified by Trump’s (apparent) defeat. But cold, emotionless stocks view this election differently. The absence of a blue or red wave leaves razor-thin electoral margins rendering big legislative change dead on arrival. However you feel about this-or-that race’s outcome, that’s great stock market news.
In October, I detailed why falling uncertainty boosts stocks after elections. Now clarity comes and stocks are jumping. Since the vote, the S&P 500 is up 7.9%. World stocks are up more, 10.3%.The divided results ushered in a do-little government bringing bullish relief here and abroad. In the House, Democrats expected to increase control about 15 seats above their 232 pre-November total seats. Instead the Republicans gained at least 10 seats—with three still undecided with Republicans slightly ahead. However they go, this will be the Democrats’ thinnest House majority since at least World War II. If the GOP takes those three, it will be their smallest edge since 1900. Hence, bold legislation is a non-starter.
Ditto in the Senate. If Republicans win at least one of Georgia’s two January 5th runoffs, they retain a slim majority. If not, it’s a 50-50 deadlock with Vice President-elect Kamala Harris casting the tie breaking vote for the very slimmest edge possible. Hence, again, minimal legislation. The margins are simply too thin. Moderate Democrats and so-called progressives already blame each other for a “Blue Wave” failing to materialize. To pass anything partisan, both sides need effective 100% uniform support—and there is nothing controversial all members of either party agree on. Any one or two dissenters can kill any issue. Things will only pass with broad agreement. Moderate democrat Joe Manchin and Moderate republican Susan Collins are reportedly talking about joining forces to ensure moderation. Gridlock rules, at least until 2022’s midterms.
Gridlock frustrates voters—who want their views to dominate, creating change. But stocks love it. I’ve studied politics’ influence on markets for decades. One constant: In developed country markets, stocks do best when big legislative risk is low. Why? More clarity for executives and investors to plan. Fewer wild cards to fret.
Legislation redistributes money, property rights, or regulations—creating winners and losers. Behavioralism shows people hate the pain of loss vastly more than loving equal-sized gains. So new legislation’s losers really hate it. Others fear they may be next to suffer. This uncertainty makes returns much less variable when gridlock rules.
Typically, new presidents arrive touting big ideas. That is when they have the most political capital, hoping to get the most done—that’s why so many people talk up actions in the first 100 days. It’s also why President Donald Trump’s 2017 tax cuts came early. Ditto for President Barack Obama’s early 2010 healthcare overhaul. That doesn’t guarantee stocks struggle—they soared in both Trump’s and Obama’s first years while their parties controlled Congress. But since good data begin in 1925, US stocks have risen in 58% and 63% of presidents’ first and second years, respectively—noticeably behind the overall 73.7% annual frequency of gains. Fear over policy shifts helps explain why.
Then midterms arrive. The president’s party almost always loses relative power in Congress, ushering in gridlock on an absolute or relative basis. Bullish! The result: Stocks have risen in 92% of presidents’ third years and 83% of fourth years. Those years also boast the highest median returns—22.6% for third years and 12.0% for fourth years, both topping US stocks’ long-term average annualized return of 10%. Now? We needn’t wait for midterms for gridlock. We get it perfectly immediately ahead.
This all augments the repeat trend I detailed here in October. When a Democrat wins the presidency, election-year returns are typically tepid before the election, thanks to biases painting the party as anti-business. But in inaugural years, stocks rebound big as investors’ fears don’t come true and relief ensues. (Vice-versa when a Republican wins.) It usually takes some time, as investors need to see sweeping change isn’t coming. Said simply, since World War II every democrat President’s inaugural year has been double digit positive except Carter’s which was only a negative 7.4%. But this year? The early, golden gridlock means no waiting—like Christmas in July.
Investors will feel that benign political backdrop increasingly ahead—helping stocks not only at home but globally. While pundits often highlight differences in US and non-US markets, developed markets typically move together. Non-US developed world stocks have a 0.85 correlation with the S&P 500 over the past 20 years—sky-high considering -1.0 is polar opposite and 1.0 is lockstep movement.
Politics are, of course, merely one factor for stocks. But after a tense election year, the long lasting relief gridlock provides blows a forward wind in stocks’ sails. Take advantage now and own stocks—at home and abroad.