Voting For Gridlock

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.

Midterm elections are less than a month away, and you know what that means: Cable pundits are earning some massive overtime. This is the home stretch! A time for grandstanding, blathering, mudslinging and other good old-fashioned family fun! Now if you're into this sort of thing, it can be entertaining political theater. If you aren't, you are quite possibly sick to death of the rancor and just want to know whether stocks will be happy with the results. If you are in the latter camp, we have good news: You can tune out the noise, because nothing in these final weeks means very much for stocks-whether campaign hijinks tip Congress one way or preserve the status quo, it is overwhelmingly likely we get more gridlock, which stocks love.

Over the next four weeks, you'll see no shortage of articles or TV reports claiming the contest is certain to go one way. These are a guesses, and useless ones. Campaigns' last legs have too many unknowns, and these races are too close to call. Take the House. On the one hand, Republicans would seem to have an edge since incumbents are hard to beat (Eric Cantor notwithstanding). The majority of the 47 total open House seats belong to the Republicans in the present House. However, of these 47, only about 18 Republican seats and 7 Democratic seats were really in play at the beginning of the year. Cantor makes 19. To seize the House, Democrats need to win all these open seats (or the lion's share and knock off a few incumbents) and about half are in traditional Republican strongholds-the sweep is unlikely. Possible! But not probable. The Senate is sort of the reverse of this. Democrats (including Senators Sanders and King, independents who typically poll with the Democrats) have a 55-45 majority. The Republicans need six to win and have the structural advantage, with fewer seats to defend in traditional Democratic territory. But they'd need a near-sweep of vulnerable Democratic seats-two in states where they're trying to defend a governorship (South Dakota and Alaska). They also have more state houses to defend in blue states-including three where they're also trying to nab Senate seats (Iowa, Michigan and New Mexico). Those governors' races could divert GOP funding away from the Senate races, perhaps counterbalancing their structural advantage. In short: The Senate could change hands, but it's anyone's guess whether it actually does.

If you're into political theater and watch exit polls with bated breath on election night, those five states are the ones to watch-even if they don't make or break the race, polling trends can show how sentiment is leaning in toss-up states. Right now, Iowa, South Dakota and Alaska are leaning red, and Michigan and New Mexico are leaning blue. How the numbers shift over the next four weeks are as a good a sign as any of where momentum is going. But really, this is a hard one. Other indicators aren't hugely helpful. For example, President Obama's poll second-term numbers near-perfectly match George W. Bush's, and the GOP was as shellacked in 2006. That could signal a big Republican win this year, but Republicans aren't rallying the way they were in 1994 or 2010. Some theorize this is because the campaign lacks a "defining issue" to galvanize the opposition-think the Affordable Care Act in 2010, Iraq in 2006-making it harder to rally those disenchanted with the administration. But we'd also note most Democratic candidates are distancing themselves from the administration, too, perhaps making Obama's ratings less of a driver than they might otherwise be.

No scientific analysis can predict the wild final swings, though. Last-minute gaffes, mudslinging and scandals are not gameable market functions, and they can radically change the landscape. The Republicans seemed to be in ok shape until the Mark Foley scandal broke in the 2006 campaign's final weeks, turning the tide. Pundits will always wonder how 2004 would have gone without the Swiftboating of John Kerry, which forever turned a campaign ad into a verb. Candidates and Super PACs save all this for the end, so it's fresh in voters' minds when they're in the booth. It's wild, crazy and unpredictable.

Regardless of the exact balance of power on November 5, however, we're near-guaranteed gridlock. If Congress stays split, gridlock stays (duh). Even if one party nabs both houses, they won't have unstoppable control-regardless of which it is. Democrats wouldn't have enough seats to end a filibuster. Republicans wouldn't have enough to override Obama's veto.

On one hand, this might be annoying, because gridlock often means squabbling, and squabbling is irritating.^[i] But gridlock is great for stocks. Gridlocked Congresses can't rewrite laws, redraw property rights or reallocate resources or capital-stocks love this stability. This is why stocks are overwhelmingly positive in midterms' aftermath. Since 1925, the S&P 500 has been positive in 86.4% of midterm-year Q4s and the following Q1 and Q2-well above the 67.4% frequency of positive returns in calendar quarters. The identical frequency is a fun coincident. The abnormally high frequency of uppytimes isn't. It's gridlock! When candidates stop campaigning, stop making big promises, cease the Swiftboating and go back to doing nothing, stocks feel relief. The strong likelihood of positivity, if you ask us, is a fine reward for putting up with all the noise.