Political Gridlock: Good or Bad for the Stock Market?
submitted by Brent Lindell

In the aftermath of Tuesday’s election, many investors are now wondering about the stock market implications related to the GOP seizing control of the House. Depending on your personal political persuasion, you are likely to jump to some conclusion. And, while it is easy to let your political bias cloud your view, we think looking at the evidence is far more instructive and likely a far better barometer of what to expect.

While hardcore liberals (typically Democrats) and conservatives (typically Republicans) naturally assume that the best outcome for the stock market is to have their candidates dominate both branches of Congress and the Presidency, evidence suggests the opposite. Gridlock (defined as neither party controlling each of the Senate, House and Presidency simultaneously) has historically resulted in the best stock market performance. In fact, lack of gridlock has historically been bad for the stock market.

A recent study by Professors Keith T. Poole and Howard Rosenthal (available at www.voteview.com) illustrates the benefits of gridlock. From 1940 to 2008, the (price only) return of the stock market when only one party controls all of the Senate/House/Presidency was 5.0% and 3.3% annually (under Democrats and Republicans, respectively).

In contrast, the market rose 10.5% annually when Congress was split Republican/Democrat with a Republican president. The very best stock market scenario was having Republican control of Congress (both House and Senate) with a Democratic President. The market was up 15.3% per year in this scenario!

Given the very slim Democratic margin in the Senate and the strong recent message voters sent to surviving Democrats, we suspect the current situation may most closely resemble the situation that has been best for the market (Republican Congress with a Democratic president). Said different, even with a Democratic Senate and Republican House, the legislation that is likely to come out of Congress will probably be somewhat right of center.

The other reason that politics may bode well for the market in 2011 is that the stock market typically does the best during the third year of the presidency. The reason is obvious. The president is trying to window dress to assure his re-election. Historically, the stock market rises 16.6% in the third year of the president’s term. In contrast, it has gone up far less in the first (4.4%), second (2.8%) and fourth (8.4%) year. So, if history repeats itself, politics could be the wind at the stock market’s back in 2011.

So why is gridlock good? My cynical side thinks that it may actually be better for the stock market if the politicians can’t get anything done. This way they do less damage, or at least the change they affect is incremental in nature due to the checks and balances inherent with a divided Washington D.C.

Of course, there is no way to say for sure if the statistics I refer to are truly indicative of what we can expect in the next two years. They may just be random noise. You know what they say … lies, damn lies and statistics. So, I certainly don’t recommend you make any big portfolio moves based on last Tuesday.

And, despite the fact that history suggests gridlock is good, I will continue to root for my preferred political party to dominate the Senate, House and presidency! But, in the meantime, your investment account may be safer if the politicians fight, bicker, and fail to get anything done.

Brent Lindell is an investment adviser with Savant Capital Management.

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