Is the Coming Political Gridlock Good for Specific Market Sectors?

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Image Credit: Kelly Bell (Flickr)

A Return to Gridlock in Washington Could be Healthy for Stocks

Political gridlock has historically been associated with higher stock market prices. So, while staunch supporters of either political party did not become overjoyed by the Election Day outcome, those invested in stocks may wind up better off. With President Biden (D) in the Executive branch, and at least the House of Representatives in the legislative branch holding a Republican majority, a split government is assured. This is true no matter the final outcome of the Senate races. A split government, with its accompanying gridlock, has been accompanied by positive long-term stock market performance.

A Smoother Road

The battles in Washington may take on a more heated tone with a split government, for investors, the gridlock scenario eliminates a lot of uncertainty. In the inflationary period we are in, a government with less ability to institute spending plans, and a reduced ability to change tax rates in an effort to pay for spending, is far less of a concern to market participants – less change will be enacted.

For businesses, there is more visibility to plan, budget, and implement plans to build their business. A split government should lead toward fewer dramatic changes or government intervention that bolsters one technology or product over another. With a lower risk of playing field changing legislation, tax change, or regulations, businesses are more likely to spend and invest as the risk of change is lower.

Historically, stocks have tended to do better under a divided government when a Democrat is in the White House. The average one-year S&P 500 returns have been 13% in a Republican-held Congress under a Democratic president and 14% when the Congress is split. This compares with 10% when Democrats controlled the White House and Congress.

Under the current situation, less spending on Build Back Better initiatives and a lower likelihood of passage of more plans like The Inflation Reduction Act help reduce spending and stimulus, which may allow the Federal Reserve to end its tightening cycle sooner.

The increase in Republicans could bring more attention to several stock market areas, such as biotech and pharmaceuticals. Their increased presence lowers prospects for price controls on prescription drugs. Big tech stocks could benefit from less of a threat to regulate the industry.

Some Choppiness Ahead

In 2011 the credit rating agency Standard & Poor’s downgraded the U.S. credit rating over the long gridlock battle that delayed increasing the Federal Debt ceiling. A possible downgrade, or “credit watch” category, could lead to an increase in rates, not just in U.S. government debt but all loans tied to these benchmark rates.

The enhanced power of Republicans could also slow infrastructure outlays, particularly the momentum in spending that has lifted so many alternative fuel stocks. Incentive plans and grants funded through borrowing and taxation have grown dramatically with both the executive and legislative branches under single-party control, those sectors that were expecting the pace to continue may find growth prospects slowing. Marijuana legalization on the Federal level may also be less of a priority now among lawmakers.

Stocks Post Mid-Terms Track Record

The S&P 500 has recorded a gain in each 12-month period after the mid-terms since World War Two. The markets have been clobbered with declining values since 2022 began; perhaps this is the turning point where the unfairly beaten-down sectors and companies begin to make up for lost ground.

Take Away

The election outcome wasn’t overly satisfying for either party but may lead to stronger stock market performance. Also, just getting past the mid-term elections without regard for the outcome has a stellar record of gains. If history is any indicator, a repeat of what the markets have experienced in the past, along with a slight shifting of those more positioned to take advantage of changes, should put investors in a positive mood as we approach year-end and enter 2023.

Paul Hoffman

Managing Editor, Channelchek



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