Friday, October 26, 2018

Investors Love Divided Government
- The "Will a Dem House Crater the Market?" Edition -


Divided Government and Markets
  Graphics from Oppenheimer Funds 

President Trump Makes a Market Prediction

On Tuesday, November 6,  voters will decide whether to buy a slightly dented, partially corroded and corrupted two year-old One Party Rule Republican Government or a shiny new Divided Government. Our Used Car Salesman In Chief is turning up the pressure for one last hard sell to close the midterm deal:

Trump Used Government Salesman
But Wait! There's More!
Not a surprising pitch given that President Trump has taken credit for every upward tick in the stock market since he was elected. It is a bit surprising that he has the time to single-handedly drive the stock market higher while the Colossus of Trump simultaneously stands astride the southern border to protect us from an invading caravan of middle-east terrorists, migrant Democratic voterswomen, kids, and babies in strollers. But I digress.

Focus Dividist! Focus! This post is about how the stock market is affected by the party in power, and the 2018 midterms...

Investing on Political Party in Office

Investing Based on Party in Power is Stupid

The Dividist has long been interested in the relationship (or lack thereof) between the stock market and the party(s) controlling our government. In particular we have often posted on the conventional wisdom that investors love divided government. But, to be clear, we're not saying we believe it. Here our oft repeated caveat on the canard that politicians of any stripe have any long term predictive effect on the stock market:
"Over the long or medium term, we do not think any attempt to correlate political parties in power and stock market performance should be taken more seriously than the Hemline Index or the Super Bowl Indicator. The reason is simple. The federal government does not and cannot control GDP, private employment, corporate profits, and/or the stock and commodity markets as much as presidents or presidential wannabes would like us to believe. 
OTOH, Studies that look for correlation between parties in power and those things that the federal government does directly control (spending, deficits, legislation, armed conflict, and currency) are interesting and informative. For that we can look to political scientists and economists like Niskanen, Van Doren, Mayhew, and Slivinski for answers. But lasting effects on markets based on party in power? No... 
Short term market effects around the catalyst of an election are a different story. Investor psychology and emotion (whether driven by fear or greed or both) can certainly drive market movement in the short term. If a preponderance of investors believe that divided government is good for the markets, than it can become a self-fulfilling prophecy."

Case in Point - What Happened in 2016

The market did very well during the last six years of divided government in the Obama administration. Conventional wisdom leading up to the 2016 election was that the market would continue to do well under the "inevitable" Clinton divided government.

When the inevitable became evitable we saw a post-election plunge in the aftermarket on November 8, only to see the stock market roar back as investors (or algorithms) began to consider the impact of a unified one party rule Trump government. The market has been off to the races ever since.

Credit where it is due. It is an undeniable fact that President Trump's meat ax approach to regulation, significant corporate tax cuts, and the consequent stimulative effect of a massive increase in deficit spending has goosed the economy and the market. Venture capitalist and former CEO of Sun Microsystems Scott McNealy best summed up the general business community reaction to the Trump vs. Obama relief rally:
"All of a sudden after the election, the waterboarding, the eight years of waterboarding stopped,'" said McNealy, who voted for Donald Trump."I think that is a strong feeling of a lot of CEOs out there," McNealy told "Squawk Box." "The regulations are coming down. The attacks from the government are coming down."
The 26% increase in the Dow Jones Index for the first two years of the Trump Presidency is indeed impressive. It is almost as impressive as the 33% increase in the Dow Jones Index for first two years of the Obama Presidency.

Trump versus Obama stock markets
Graphic from Facts First
What is not clear is the counterfactual of what would have happened to the markets if a Clinton divided government was elected. Certainly, there is a case to be made that the markets would still have gone up - as expected - as a continuation of the Obama divided government bull market. Perhaps at a slower pace. Perhaps with less volatility absent concerns about trade wars, exploding unsustainable debt, chaotic foreign policy, and Trump's blustering authoritarian leadership style. But that is just speculation.

Having Said it's Stupid to Predict Markets Based on Election Results, We'll Now Look at Predictions for the Market Based on 2018 Midterm Results

Enough of the Dividist's opinions on politics and markets. Let's look at the interesting dichotomy in investor sentiment for the 2018 midterms. What does the professional investor class think? For your consideration, we offer a selection of market punditry on whether or not a Democratic House majority and divided government will crater the market and economy as the Huckster in Chief would have us believe (SPOILER ALERT - No):

Reuters cites Oppenheimer and reports the conventional wisdom in "What the Midterm Elections Mean for the Markets":
"Markets Seem to Prefer a Divided Government - Investors fear that a divided government—with a Democratic-controlled House of Congress in opposition to a Republican administration—could derail President Trump’s agenda and put an end to the historic bull market. But throughout history, markets have often performed better with a divided government."
"Gridlock in Washington would prevent the government from enacting new policies, keeping the status quo -- at least from Wall Street's perspective. A split decision from the midterms would probably keep America's fiscal, trade and regulatory policies on the same trajectory. 
"Divided government is increasingly the most likely case, with limited ramifications for markets," Morgan Stanley strategists Michael Zezas and Meredith Pickett wrote to clients last week. Barclays agrees. "A Democrat win of the House would likely lead to government gridlock," the firm wrote last week. "No market-moving legislation is likely to pass through Congress."
Conor Sen - writing in Bloomberg makes an even more dramatic claim - "After a Trump Impeachment, Expect the Market to Bounce":

"And if Trump is kicked out of office, expect the stock market to bounce – not crash. By the point in an economic downturn when Republicans are ready to abandon him, we'd probably be closer to the trough of that downturn than to its beginning peak. So it's not necessarily that removing Trump from office and replacing him with Vice President Mike Pence would directly lead to a strong economic environment. It's just that the impeachment would reflect an aging downturn, and the period after the impeachment would overlap significantly with the inevitable recovery. Naturally, that won't stop Trump's successor from claiming credit."
Goldbug and perma-bear Peter Schiff offers a dissenting view in his podcast "Divided Government Would Not Be Bullish for the Stock Market":
"The stock market bulls are saying that if we have divided government that this is historically positive for the markets, and therefore it will be yet another positive for this stock market ...This is a bunch of nonsense. Obviously, if we lose control of the Congress, if the Democrats take control of Congress, if you were hopeful that we would have more deregulation, then your divided government will put a stop to that. So, if divided government stops government from getting smaller – if that was ever going to happen – then it is not a good thing... 
Nothing that Trump wants to do will get through Congress, so if you’ve been betting that it would, then the Republicans losing control of Congress is definitely a bad thing … Why would losing a Republican Congress that is thought to be supportive of business and a pro-business agenda, why would losing control of Congress to the Democrats – to socialist Democrats – why is that bullish for stocks? How could you possibly think that is bullish for stocks? If you think what we have now is bullish, and now we lose a chunk of that, that just shows you that it doesn’t matter what happens. These analysts are always going to say it’s bullish. No matter what happens, it’s bullish for stocks because stocks are going up because we don’t want to even fathom the possibility that something that could happen would be negative for stocks.”
We should note that Peter Schiff was a favorite on this blog in the past. He famously predicted the 2008 financial crash. He has also been predicting an even bigger financial crisis ever since. Eventually he'll be right. Also eventually the earth will be burnt to a crisp by an expanding red giant sun. That won't happen for a few billion years. I don't know when Schiff''s crash is going to happen. Timing is everything.

Ken Fisher has also been a long-time favorite on this blog. His mix of investment advice, election analytics and political skepticism makes him a compatible fellow traveler for the Dividist political philosophy. His recent posts and podcasts on his corporate site, as well as his columns in USA Today explain "Why midterms should boost the stock market, 401(k)s":
"Democrats will gain seats in the House of Representatives, maybe enough for control, while Republicans may gain slightly in the Senate. The real winner for markets, though, will be gridlock, in which no major legislation gets passed. And that’s bullish for stocks. Why gridlock? Because a decisive number of seats won't swing to one party or another.Democrats either win a tiny House majority or miss by a whisker... 
Without gridlock, markets face the possibility that big legislation could pass, and that causes risk aversion to rise among investors. This is why stock returns during a president’s first two years are weaker than years three and four. In the second half, after midterms render gridlock, legislative risk eases. With political uncertainty decreased, stocks party. We haven’t had a negative third year of a president’s term since 1939, when World War II was exploding... 
Simple fact: Come hell, hill or high water, the Standard & Poor's 500 index has been positive in 87% of the fourth quarters of all midterm election years, ever.  It gets better. It’s also been positive in 87% of the quarters that follow — the first calendar quarter after the midterms. That’s six months running. It’s the most consistent positive streak in all history. Those six months typically render a 14% rise."
The Dividist finds Fisher's historical data to be more compelling than Schiff's hand-waving argument invoking investor's feelings about the bull market and midterm results. Your mileage may vary.

Michael Townsend at Charles Schwab takes detailed look at the midterms,asks "What's at Stake in the House?" and concludes "meh":
"Market Reaction Likely Muted - Markets seem to be anticipating a divided government after the election, so their reaction may be muted if there is a changing of the guard. Other factors, including the Federal Reserve’s interest-rate policy, corporate earnings and the ongoing trade dispute with China, are more likely to influence the markets than the election outcome."
CNBC's Market Insider assessed the betting odds for both Red & Blue waves and surveyed a variety of market pundits in their article: "The stock market wants a Republican wave but expects to see two-party control of Congress", all to conclude it doesn't matter. No matter who wins the midterms, the markets will win:
"Unanimously everyone believes the Democrats are going to take the House and the Republicans are going to control the Senate," said Julian Emanuel, chief equities and derivatives strategist at BTIG. "From our point of view, when we think about what is a potential surprise to the markets place...the biggest surprise to us would be if the Republicans held the House." He said no matter who wins, stocks should bounce but with Republicans they could bounce even more. "The data would show you if the Republicans are successful at holding unified government, the odds are that could spark serious upside," Emanuel said. "…In the event the Democrats take the House, the resolution of uncertainty…could be enough to keep stocks moving forward."

The Final Word on Markets, Divided Government, and the "Pelosi Bull Market"

We could go on, but why waste time with pundits when we could go straight to the source? Let's check in with an insider in the administration - President Trump's top economic adviser in the White House - the Chairman of the National Economic Council - Larry Kudlow. He has a few things to say about divided government and the potential market impact of Nancy Pelosi as Speaker of the House:

"What about cap gains, what about dividends, what about trade protectionism, what about health care spending, what about overall spending? If I believe stocks are efficient markets... right now they are not voting against the Democratic House  ... Bad Republican polls - great looking stock market - in all seriousness, in all sincerity, let's be honest and objective about this... Is this the Nancy Pelosi divided government bull market?" - Larry Kudlow
Why yes, Larry. Yes it is. 

Vote for Divided Government on November 6

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