Investors Still Love Divided Government

Investors Still Love Divided Government


Early in July, we took note of a CNBC panel discussion worrying about a Double Dip and Ron Insana offering an explanation for a stock market rally in the midst of unrelenting bad economic news.

“All of a sudden there are some reports coming out saying the politicians are underestimating the possibility the Republicans take either one or both house of Congress. If that political uncertainty disappears and you get a Democratic President and a Republican Congress – that is the best combination for stock prices.” – Ron Insana

On that day the Dow closed up 276 points at just over 10,000, and since then added another 10%+ (trading at 11,126 as I write this). As I have said before, I do not believe there is any case to be made for a statistical correlation between market direction and political parties in power that will stand up to rigorous mathematical scrutiny over the long term.

However, in the short term, if investors believe that divided government is good for markets, then that expectation can be a self-fulfilling prophecy. That may be what we are seeing in the market now in anticipation of the November results. This expectation of divided government is gaining momentum and the meme is getting traction in the MSM. Two recent examples:

USA TODAY: Voters may sway stocks with possible policy changes

“Forget price-to-earnings ratios. Buy-and-sell decisions on Wall Street are increasingly being driven by power and politics and what voters will do at the polls…

Even though Obama and Democrats swept the polls in the 2008 election, investors would prefer a split Congress, as a balance of power on Capitol Hill makes it less likely that the Democrats will be successful in passing what Wall Street perceives as an investor-unfriendly, growth-challenged agenda.

“A dramatic change in the composition of the House and Senate could significantly alter the legislative strategy for all political leaders, including President Obama,” says Jason Pride, director of investment strategy at Glenmede.

Historically, divided government has been bullish for stocks because it results in what Wall Street refers to as legislative gridlock. And in the words of many Wall Street analysts and economists: Gridlock is good.

Heh. Where have I heard that before?

A couple weeks ago, in the face of yet another bad jobs report, the market rally continued, prompting an interesting segment on the Larry Kudlow Report. A panel including Steve Moore (who worked for Dick Armey in ’95) and David Goodfriend (who worked for Bill Clinton in ’95) discussed whether the market’s continuing strength was attributable to an anticipation of the return of Divided Government:

Money quotes:

Why did stocks rally though 11,000 today? on this poor jobs report? Might it be hope for Republican tsunami in November? … I have this suspicion that the stock market is mightily rooting for a Republican tsunami on November 2nd. – Larry Kudlow

“I am not saying this as a Republican – I just think that the financial markets want to see divided government. One party control has not been good for financial assets and it has not been good for workers. – Steve Moore

The most interesting exchange is between Goodfriend and Moore (around the 5:30 mark) arguing whether Republicans or Democrats could take credit for the prosperity and relative financial sanity that prevailed during the Clinton/Gingrich divided government. I am happy to give credit to both, and to the benefits that accrue when divided government keeps the worst impulses of both parties at bay.

Lest anyone think that Republican Kudlow is being disingenuous and flogging self-serving Republican spin when he asserts that the investor class prefers divided government – let me reprise one of my first YouTube efforts. This from from four years ago, shortly before the 2006 mid-terms. Here we see the selfsame Kudlow noting a rally, wondering if the markets are anticipating the Democrats taking the majority and restoring divided government, prompting what he then called the Pelosi Bull Market:

Is 2010 like 2006? Kudlow thinks so, and the Intrade prediction market is giving the Republicans better odds of retaking the House now than it gave the Democrats in 2006.

In any case, If you have been fully invested since the Insana piece ran in July – so far, so good (Past performance is not a guarantee of future results).

x-posted from “Divided We Stand United We Fall”

  • michael mcEachran

    So the Dow peak in April, 2010, of over 11,000 was becuase of…?? Clarvoiant investors who predicted that Republican chances would surge before the midterms? And I guess the recent positive economic indicators has little to do with the up tick in the market. I’m amazed at partisans’ abilities to spin any news to their benefit.