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Is Gridlock Good?: A Look at Market Returns During Periods of Policy Stalemate

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It’s a new day on Capitol Hill with a divided group of lawmakers ready to rumble: Democrats will control the Senate and the presidency with Republicans running the House.

The political reality of such divided government and potential policy inaction might encourage investors. After all, the less legislation these lawmakers can pass, so the thinking goes, the better for the economy and capital markets. Elected officials mired in partisan bickering and rhetorical fire-bombing are less capable of passing damaging legislation that can suffocate investment markets.

History indicates otherwise, however. Gridlock in fact is not good, says S&P’s Sam Stovall.

Stovall examined the S&P 500’s annual price performance during three political scenarios. First, he looked at a so-called “Total Unity” scenario, where both the president and both houses of Congress were from the same party. Under this scenario, the S&P 500 posted its strongest annual performances, gaining 7.6% since 1900, versus 6.8% for all years, and 10.7% since WWII, versus 8.4% for all years.

Under “Partial Gridlock”, where there was a unified Congress but a president from a different party, the S&P 500 posted annual returns that were close to the average advance for all years, rising 6.8% in 32 years since 1900 and 7.6% in the 30 times since 1945.

Under “Total Gridlock” – a split Congress – the results weren’t encouraging. Since 1900, the 500 rose only 2% per year, performing better under Republicans than under Democrats. Since 1945, the market gained only 3.5% per year.

The rationale behind this sub-par performance could be that gridlock generates uncertainty, says Stovall, and Wall Street hates uncertainty. He emphasizes though that there have been limited examples from which to draw conclusions – only 12 since 1900 and eight since 1945.

Of course, the strategist concedes that maybe all of this analysis is simply another example of coincidental correlation, and that the market’s performances, along with its sector returns, had nothing to do with the makeup of our executive and legislative branches of government.

But Stovall believes otherwise. He argues that investors look to Washington for leadership, not obstacles. A split Congress like the one we have now may just end up adding one more stone to this already high wall of worry, he says, limiting the otherwise strong performance that is typically seen in a president’s third year in office.
POSITION:  No positions in stocks mentioned.