The elections: Why gridlock could hit stocks


political gridlock on telephone poleThe mid-term elections on Nov. 7 are now less than a week away. Polls indicate that Democrats are coming on strong. In fact, a Wall Street Journal/NBC News poll released today found that 52% of voters hope Democrats will control Congress vs. 37% who root for Republicans.

Looks like we may be in for a bout of governmental gridlock -- when opposing parties control the executive and legislative branches. Traditionally, investors cheer at this prospect (indeed, that may be one reason the market has fared so well in the past month). The theory is that when there is gridlock, the Federal government isn't able to get that much done and investors don't have to worry about pesky issues like healthcare reform, tax increases or major policy shifts of any kind.

That's the theory anyway. But it doesn't quite pass the smell test, if you ask me. Is it really the best thing for our country, economy and stock market at this point in time to have an ineffectual Federal branch? I don't think so...

Sure, simple numbers back up the gridlock gibberish. In an Oct. 25 report, The Schwab Center for Investment Research found that in calendar years in which there was gridlock, stocks returned 14.08%. But in years where the same party controlled the legislative and executive branches, the average annual return was 10.41%. Still, Schwab analysts conclude on deeper analysis, "There is no statistically significant relationship between political control of Washington and the stock market."

Truth is, a growing cadre of analysts, including the folks at Stock Trader's Almanac, are arguing that the mid-term elections this time around may have the most in common with 1994. That was the year when Clinton was President, Democrats lost control of Congress, and stocks fell in the five days leading up to the mid-term elections for the one and only time since 1934. The Almanac's analysts warn investors today, "enthusiasm that lifts stock prices may dissipate within days of the final tally." Hence -- even if there was a pre-election gridlock euphoria in the market lately, chances are you've already missed it.

Here's an even scarier take: Doug Roberts worried recently on Blogging Stocks that a Democratic Congress and Republican president could be a terrible combination for the stock market. He conjured up a future where a Democratic Congress is spending on social programs to earn fans in advance of the 2008 Presidential election at the same time President Bush continues to cut taxes to boost the Republican cause. The result would be even worse fiscal imbalances than we already have. That would inevitably lead to higher interest rates down the road, Roberts argues. Egads.

There's even a case building in these final pre-election days, that ever-confident Republicans may surprise us all by winning a majority in Congress yet again.

The market has had a great run in the past month. But one reason it has wobbled in recent days may be because investors are already starting to wonder if the "gridlock is good" theory is all its cracked up to be. Even if you still buy it, keep in mind, it is probably too late to play that investment card, anyway.

[Photo: Richard Summers]

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Last updated: February 13, 2012: 02:49 PM

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