SOTU Puts Congressional Inaction in the Spotlight

So last night was the State of the Union, and honestly, regardless of which party is in power and who is president, these pageants are just tiring. We would be happy to pretend the US men’s gold-medal-winning Olympic hockey team entered the House balcony and waved to the chamber for no particular reason other than the occasion of their own awesomeness.^[i] But there were policy things, economic policy things specifically, which financial headlines are talking about a lot. So let us quickly guide you through this from a stock market perspective.

You might not always see this demonstrated in their daily movement, but stock markets are mostly rational creatures. Unlike humans, they lack political bias. They don’t get distracted by colorful rhetoric and which adjectives politicians use to describe the economy. They don’t prefer any party or politician over another (and, disclosure, neither do we!), and they tend not to have human viewpoints like whether a policy is good or bad. Nor do they care much about a policy’s intent. Rather, as they weigh legislation and its likely effect, they look at the core issues. Will this create winners and losers? Are property rights going to change in a way no one expected when planning investments? Is this going to create uncertainty that delays risk taking? When Congress is very active, markets have to think about this a lot, which raises legislative risk aversion. When Congress does little, it frees markets from this thought exercise, letting them move on to happier things. So in general, we think stocks prefer gridlock.

And judging from this State of the Union speech, gridlock likely reigns. Long though it was, President Donald Trump’s oration contained precious few policy initiatives. And those that did get an airing seem to have something big in common: They aren’t traditional Republican policies. Consider the proposal to enroll the tens of thousands of American workers who lack an employee retirement plan into a federal option, similar to the Thrift Savings Plan federal employees use, with a $1,000 annual contribution match. This builds off a provision of the SECURE 2.0 Act, which was bipartisan but signed by former President Joe Biden. It offered a 50% annual match, up to $1,000 annually for individual filers, for low-income workers’ pre-tax contributions to a traditional 401(k), IRA or other qualified account. Expanding this to create a new federally administrated retirement account out of whole cloth, complete with subsidies for an estimated 57 million eligible workers, is a massive cost and undertaking. This isn’t traditional Republican territory, especially with deficit concerns getting louder in some corners of the GOP caucus. It would likely require significant cross-party support to pass, especially given the Republicans’ edge in the House is presently just 218 – 214 (with three vacancies) and three Senate seats.^[ii]

So would several other policies mentioned last night. Banning private equity and other large corporations from purchasing single-family homes is a long-running talking point among Democrats. So is capping prescription drug prices. And on the economic and personal finance front, that was pretty much it. The only other elephant in the room is the new round of tariffs, which would either require Congressional approval to extend beyond 150 days (presuming they withstand legal challenge within that window, which isn’t assured) or shift to a third different legal tool subject to different restrictions. Given the symbolic House vote to revoke tariffs a couple weeks ago, tariff legislation looks likely to encounter gridlock, too.

Now, you might logically ask: If Trump is proposing things Democrats like, wouldn’t they jump at the opportunity, negating gridlock? We doubt it, and for a simple reason that has nothing to do with anyone’s personality. This is a midterm election year. Congress tends not to do much in midterm election years. When you pass legislation, you lose the ability to hit the stump saying, “Vote for me and I will do this thing.” You lose something to motivate your donors to fund your campaign. This creates a massive disincentive for Congressional Democrats to support Trump’s ideas even when they agree with them. Giving their opposition a win and vaporizing the wedge issues they need for campaigning and fundraising would hamper their midterm runs greatly.

So we probably get gridlock this year. But the market implications here are a little tricky, because midterm years also bring higher overall uncertainty. That can counterbalance gridlock’s bullish effects and raise volatility. The result, often, is a stock market grind early in the year. The tailwinds generally kick in later, once the midterm races become clearer and markets can better see the likelihood that gridlock deepens after the vote, given the long history of the president’s party losing relative power at midterms. This tends to kick off a wonderfully bullish stretch of the political cycle, which extends into the third year of the president’s term.

None of this means US stocks do badly early this year. They probably continue lagging the rest of the developed world, and more volatility wouldn’t surprise. But economic fundamentals and sentiment point to fine returns overall, and there is no predicting when, precisely, the midterm-related tailwinds will kick in. We think this is a time to dig in, hold on through the ups and downs and be sure you are ready for the party to start.