Market Analysis

Could a Democratic President and a Republican Congress Mean More Gridlock?

Oh the places this election could go!

We did not hear Ted Cruz’s speech, but we are told it didn’t rhyme. Photo by Mark Wilson/Getty Images.

Editors’ Note: Our discussion of politics and elections is purely focused on potential market impact. Stocks favor neither party. Believing in the market/economic superiority of one group of politicians over another can invite bias—a source of significant investment errors. 

So a guy sent a tweeti at midnight Monday, and presto, America got her first official 2016 Presidential candidate. If you hate political noise, you are out of luck, because it will only get louder over the next 19 months and 16 days. We’ll get stump speeches, grandstanding, mud-slinging, scandal, viral videos and Saturday Night Live parodies. Social media will become unbearable for many. Pundits will overthink poll numbers and try to convince us Thing 1 will beat Thing 2 because of his/her stance on some big-in-Iowa fringe issue. We’ll hear how Thing 1 will destroy jobs and Thing 2 will bring an economic miracle. We’ll hear Thing 2 is economic poison and Thing 1 holds the key to prosperity. And it will all be meaningless static. No one knows today who the nominees will be, never mind who will win on November 8, 2016. Or what that person will do once in office. Or what stocks will do. But we do know two things: Stocks have zero party preference, and if gridlock goes away, things could get dicey.

It is impossible to handicap the election today. One, the field is wide open. Only Senator Ted Cruz (R-TX) is officially running—you might know him from his 21-hour speech against the Affordable Care Act during 2013’s budget debate (included: a reading of Green Eggs and Ham, since he was missing his kids’ bedtime story). Senator Rand “Audit the Fed” Paul (R-KY) is supposedly announcing his candidacy April 7. New Jersey Governor Chris Christie, Wisconsin Governor Scott Walker, Florida Governor Marco Rubio and former Florida Governor Jeb Bush round out the GOP probably-wills, but the “maybe” list is a cast of thousandsii. On the Democratic side, despite talk of a Hillary Clinton coronation, former Maryland Governor Martin O’Malley spent the weekend trooping through Iowa. Former Senator Jim Webb (D-VA) hasn’t announced his candidacy but has a snazzy campaign website. Joe Biden is pondering a bid. Senator Bernie Sanders (I-VT) is “prepared to run.” Senator Elizabeth Warren (D-MA) claims she isn’t, but tell that to her fans. Fans are similarly stumping for another Al Gore run.

Opinion polls kindly try to sort through this hodgepodge of names for us, but polls this early aren’t predictive. Could it be Bush vs. Clinton, as the latest polls suggest?iii Sure! But polls in March 2007 predicted Clinton would face off against Rudy Giuliani in 2008. They were wrong then, and that was before Benghazi and Emailgate.

Actually, let’s look at the entire March 2007 Gallup poll, because it is funny.

Exhibit 1: March 2007 Presidential Polling

exhibit 1

Source: Gallup, as of 3/23/2015.  Preferences for Party Presidential Nominee in 2008, March 2-4 USA Today/Gallup Poll.

Yes, that really is Al Gore in third. Mike Huckabee really is missing from the Republican list. We also checked whether “Tommy Thompson” should have been “Fred Thompson,” as we remembered only Fred running, mostly because he is very tall and starred on Law and Order for a decade. Turns out it really was Tommy, the former Wisconsin Governor and Secretary of Health and Human Services, who briefly ran (and who should not be confused with this Tommy Thompson, a fugitive treasure hunter). Fred Thompson hung in several months longer, further demonstrating early polls’ problems.

For investing purposes, most of this is beside the point—pure political science. Markets tend not to get bogged down in the noise. You’ll probably hear talk of parties and candidates being good or bad for markets, but that’s just opinion and bias—not factual evidence, and not true. Stocks don’t prefer either party. A roughly equal number of bear markets has begun on each party’s watchiv. Stocks care about radical legislation, period, and both parties are equally adept at bad-radical. A Democratic White House and Congress enacted 1978’s Humphrey Hawkins Act, but a Republican White House and Congress gave us Sarbanes-Oxley.

For investors, the big question is: Will 2016 renew gridlock? If so, that would be a nice political positive—it doesn’t mean stocks automatically rise, as 2016 is too far-future to game economic and sentiment drivers, but it would be a plus in the political column. If gridlock goes away, it would be a minus.

We can’t know today whether gridlock will stay. The Democrats have an edge in the Senate race—fewer seats to defend in traditional opposition territory—but they have a disadvantage in gubernatorial races, which could divert cash. Plus, the Republican Senators playing defense in 2016 aren’t exactly vulnerable—Chuck Grassley (IA), Marco Rubio (FL)v and Rob Portman (OH) are basically shoo-ins, requiring the Democrats to sweep the rest. Including McCain’s seat. This could happen if the Democratic Presidential candidate wins and generates big coattails, but it will be an uphill climb.

So one higher probability outcome is a repeat of what we have now—Democratic President, Republican Congress. More gridlock! But we could also get a clean Republican sweep, which would end gridlock. This would also introduce what we call the “Perverse Inverse,” markets’ tendency to rally in election years when Republicans take the presidency from Democrats, then fall the next. (Exhibit 2) In our experience, most investors lean Republican and see their campaign pledges as market-friendly, lifting election-year sentiment—teeing up big disappointment when the new president moderates. A Republican sweep could push sentiment into euphoria in 2016 but create lofty expectations for 2017, potentially setting markets up for a drop.

Exhibit 2: The Perverse Inverse

exhibit 2

Source: Global Financial Data, Inc., as of 1/15/2015. S&P 500 Total Return Index, 1926 – 2014.

None of this is knowable today, and by no means should an election that’s 19 months, 16 days and two candidates from now affect your investment decisions. This is just a risk to keep in mind and a reminder political biases blind. By all means, have opinions about candidates. That’s what the electoral process is for! But many investors just can’t turn off these opinions when weighing investment decisions, a common error that prevents you from seeing the world clearly.

i We aren’t very hip, so we aren’t sure this is the right verb. Does one indeed send a tweet? Or make a tweet? Do a tweet? Post a tweet? Tweet a tweet?

ii Ok not literally—we counted nine.

iii If that does happen, can we get a Perot, too? For fun?

iv One party has one more bear, but that’s because the S&P 500 has had 13 bear markets, and 13 is an odd number.

v Obviously his likely Presidential candidacy is a wrinkle here, though not enough of a wrinkle at this juncture to alter the point.