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There’s no doubt that investors thought a GOP mid-term victory would be good news for stocks. For proof, simply note the Dow run-up in the months leading up to the elections.
When I wrote Why You Should Buy Stocks and Houses Now back on July 6, the Dow was at 9,686. On election day it opened at 11,125 – 15 percent higher. Granted, the looming Republican victory wasn’t the only positive influence on stock prices, but there’s little doubt that it played a role in market optimism.
But now that the victory is at hand, will the economy and its proxy – the stock market – continue to head higher? While the jury is still out, there’s cause for both optimism and concern. Optimism because stocks have historically done well in the year after mid-term elections. Concern because the potential gridlock ahead could be devastating.
The bad news: gridlock during a delicate time
Now that Republicans have a majority in the House of Representatives, the ability of the government to act quickly or decisively to stimulate the economy could be compromised. While this has often been a good thing in prosperous times, it could be a dangerous thing when times aren’t so good. Potential areas where a stand-off between the White House and the Congress could hurt more than help:
- Bush tax cuts: As we said in our September 27 story Should the Rich Pay Higher Taxes? Republicans favor keeping all the Bush-era income tax cuts in place, while the President wants to let them expire for Americans earning more than $250,000 per year. This problem will have to be resolved prior to the newly-elected Congress taking their seats – if no agreement is reached and nothing is done by year-end, the tax cuts will automatically expire for everyone. And that could cripple the recovery, since it would leave us all with less disposable income to spend. Likely scenario? The cuts will be extended for all, but only for one year – then the partisan bickering will begin again.
- An end to stimulus spending: With unemployment still hovering at 9.6 percent, some economists believe that additional government spending may be necessary to create jobs. But stimulus spending, like the recently announced $50 billion plan to Renew and Expand America’s Roads, Railways and Runways, is precisely the type that the GOP’s Pledge to America vowed to end. Also likely: Congress may not extend unemployment benefits to the nation’s 6 million long-term unemployed. Less spending could hurt the economy, and in turn the stock market.
- Financial regulation and healthcare reform: Many Republicans campaigned on repealing financial regulation and healthcare reform – a movement many Wall Street companies support, especially banks, brokerages, and insurance companies. But with Obama still holding veto power and Republicans without enough votes to override a veto, the result may be nothing more than uncertainty. And as much as the stock market hates government regulation, there’s something it hates more: uncertainty.
In short, as the reality of a Congress unable to act settles in, the stock market might take a look and not like what it sees, especially if the future is uncertain or the economy weakens further and the government is unable to intervene.
All the news isn’t bad
According to Fidelity Investments, stocks soar the year after midterm elections, no matter which party is in charge or whether or not there’s a divided government. From 1950 to 2009, stocks averaged 11 percent per year. But in the year following mid-term elections, the average return was 23 percent, and that return didn’t vary widely whether there was harmony between the White House and Congress or not.
Another possible positive: potential compromise between the White House and Congress. Lawmakers in both parties could come together and vote on tax reforms that might benefit corporations, individuals, and the economy.
And there are areas where Republicans and the President have common ground. For example, the White House is currently working on a free trade agreement with South Korea – something many Republicans could support.
Here’s what I’m doing
As you may already know, I maintain a public, real-money portfolio of stocks I own. I’m a long-term investor, not a trader, and I’m not making any immediate changes. Now that the elections are behind us, history would suggest that January will mark the start of a good year. If the economy is already well on the road to recovery – and I believe it is – a little gridlock might be irritating but not necessarily bad for our economy. Nor would reducing government spending and lowering our massive federal deficit, something both sides of the isle have said they want.
But if the economy shows signs of weakening and Uncle Sam is unable to help due to partisan bickering, all bets are off.