Reason #529 Why Stocks Love Gridlock

Stocks like it when Congress looks like this (figuratively). Photo by Keystone/Stringer/Getty Images.

As a reminder, our political commentary is intended to assess potential market impact. We favor neither party, and ideological bias is dangerous in investing.

Late Tuesday, President Obama dropped his State of the Union proposal to tax 529 college savings plans. Most Americans familiar with the plan apparently hated it, and lawmakers from both parties said they wouldn't pass it. And thus, gridlock prevented a radical tax proposal from becoming law. This, folks, is Exhibit A of why markets like gridlock-and today's gridlock should help keep this bull market going.

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529 savings plans are kind of like Roth IRAs, but they're for college expenses instead of retirement. Each plan has one designated beneficiary. Contributions can be invested and grow tax-free, and withdrawals are also tax-free as long as they're for college tuition, textbooks and (in most cases) room and board. There are some sticking points and caveats, of course, so call your tax advisor if you want detailed scoop that relates to you, but that's the general gist.

Obama didn't propose scrapping all the tax advantages-just ending tax-free withdrawals. So investments would still grow tax-free (i.e., no capital gains, dividend or interest taxes), but beneficiaries would have to pay ordinary income taxes on every distribution. This, naturally, was unpopular. While the administration claimed 529 plans disproportionately benefit high-income families, nonpartisan groups and pundits from both sides of the aisle cited research showing 70% of families with 529 plans aren't high-income, and millions of families would be hurt. House Speaker John Boehner (R-OH) said it wouldn't fly. Former Speaker Nancy Pelosi (D-CA) argued against it. And so the unpopular proposal died, a victim of gridlock.

Most of this saga is sociological, outside markets' realm. The argument over who benefits more from 529 plans has nothing to do with markets.^[i] Taxing 529 plan withdrawals would probably have no impact on stocks. Families would still save for college and probably invest those savings, whether in a 529 plan (where they could still avoid capital gains taxes) or in another vehicle. Demand for stocks wouldn't suffer. Scrapping the proposal probably will help families! But markets are cold and often don't care about that.^[ii]

Still, this is illustrative. This proposal was contentious. Not for stocks! But capable of creating winners and losers all the same. If Congress won't pass this, it seems likely they won't pass anything bigger and more radical that could impact markets. If Congress refuses to touch a bill that only partially strips tax benefits from one savings vehicle, they probably won't consider bills that radically shift property rights, resources or capital from one group to another. Or rewrite regulations wholesale, creating uncertainty for businesses and people. Or do anything else huge that could spook markets.

This is why stocks like gridlock. Gridlock keeps the risk of big scary changes low, letting stocks worry less and rise higher. Gridlock is also one of the few reliably positive features that doesn't get priced in, because people hate it. Intuitively, we know partisan people hate it when their party's proposals can't pass-gridlock frustrates both sides. We also know many independents hate the bickering and crave bipartisan compromise. There is also some data to back these intuitions. In recent Gallup polls, more Americans have cited government dysfunction as the country's biggest problem than the economy or unemployment-it ranked first in four of the last seven months and for 2014 overall. A Wall Street Journal/NBC poll taken just before the State of the Union showed 59% of respondents thought a divided government was detrimental to America versus 35% who thought it a positive.^[iii] Congress's approval rating hasn't exceeded 20% since 2010, when gridlock set in. For comparison, Congressional approval spiked when gridlock was low during Obama's first two years and George W. Bush's first six-and tanked during Bush's gridlocked final two years. This dissatisfaction blinds investors to gridlock's benefits. Most never consciously see them! A switch doesn't flip, making people realize gridlock is good. Scary laws just fail to materialize and folks go about their lives with one less thing to worry about.

Ultimately, gridlock brings markets subconscious relief, a big unseen positive.

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[i] Though it does illustrate the squishiness of how statistics are often used. The administration's claims were based on data showing 70% of account balances were owned by families making $200,000 or more annually. Not 70% of accounts. There is also the matter of where those families making $200,000 or more lived. Were they in the heartland, where $200,000 goes far? Or on the coasts, where it doesn't? Again, all sociological, but interesting if you're into sociology and important for anyone weighing statistics to understand.

[ii] That makes markets sound rude, so we feel compelled to point out we still like them and forgive their callous nature.

[iii] In two separate questions, the same poll ironically showed 55% of respondents thought Congressional Republicans had been "too stubborn" in their dealings with President Obama, and 45% of respondents thought the opposite. It's probably too simplistic to add the two and conclude 100% are fed up with a lack of cooperation-it's just an interesting coincidence that the two numbers are exactly reversed.