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Elections: How Might a Change in Congress Affect the Markets?

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September 27, 2016
U.S. Capitol: Congressional leadership, the election, and how it may affect markets

About a decade ago, a study found an interesting trend: When Congress stayed home, the stock market did better. Through that time, about 90% of the capital gains over the life of the Dow Jones Industrial Average (DJIA) had come on days when Congress was out of session.

Luckily for political junkies, Congress isn’t going to just stay home. A new Congress gets sworn in this coming January and ultimately may address many issues with implications for the stock market, including taxes, drug prices, international trade deals, infrastructure spending, and immigration. And if Democrats regain the Senate, which of course isn't a given, there are potential implications for a wide assortment of legislation. Usually, but not always, the first year of a new Congress with a new U.S. president is a busy one, unlike the current situation in Washington.

“It's basically been a do-nothing Congress, and it's a lame duck situation, with everyone waiting to find out who becomes the new president,” said Sam Stovall, managing director at S&P Global Market Intelligence.

What’s the significance of a new Congress for the stock market? A lot depends on who wins the presidency and which party controls which houses of the legislature. All anyone can do now is make educated guesses based on history and the polls.

Current Gridlock Accompanied by Strong Stock Market

The divided situation during President Barack Obama’s second term, with a Democrat in the White House and Republicans in control of one or both houses of Congress, corresponded with a nice performance from the stock market. The S&P 500 Index (SPX) is up 52% since the end of 2012. Republicans controlled the House that entire time, and Democrats and Republicans switched control of the Senate, with Democrats yielding to Republicans in the 2014 election.

“The irony is that the market doesn’t like uncertainty, but at least it has the certainty of knowing nothing with major impact is bound to happen with a divided Congress and president,” said Patrick O’Hare, chief market analyst at Briefing.com.

Senate Win for Democrats: What Would It Mean?

So should bulls hope for more gridlock in the years ahead? It might be in the cards. Polls indicate that Democrats could keep control of the White House and Republicans could maintain their House leadership. The Senate is more of a question mark, with some polls showing a chance for Democrats to regain power there. But a president may need support from both houses of Congress to really make an impact.

“To get major legislation passed, the type that can make a big difference in terms of economic prospects and earnings, you’ve got to have Congress involved,” O’Hare said. “Even though the presidential candidates promise a lot of things and are talking tough on issues, it’s going to take three to tango. You need the president, House, and Senate, and it’s all got to come together between those three to get major legislation through and passed.”

A divided Congress doesn’t necessarily mean a strong market, Stovall warned. The market performed well from 2010 to 2014, when Congress was split, but that may have had more to do with low interest rates and recovery from a bear market. Now, with many expecting interest rates to go up, there may not be as big a tailwind. “If we go back to a split Congress and nothing gets done, that could work against us, not help us,” Stovall said.

Assuming Democrats win the Senate and Clinton wins the Presidency, gridlock could continue, potentially presenting a barrier to some of Clinton’s big-ticket economic initiatives, including plans to rein in pharmaceutical costs, protect trade deals, and change the tax system. A Republican House could be like a safety in football, knocking down any long passes that get through.

And don’t forget those budget battles that caused a government shutdown a few years ago. Back then, House Republicans and Senate Democrats, along with President Obama, agreed to compromise, but the stock market took a hit during the political brinksmanship. A divided Congress could potentially mean new skirmishes over the budget, with accompanying stock market volatility. “There’s a chance for more government shutdowns or threat of government shutdowns if we have a split Congress,” Stovall said.

Congress Likely Wary of Both Hillary And Donald

Even if Trump wins the Presidency, he doesn’t necessarily get a blank check from his own party. Trump’s proposals to place more barriers on international trade and to take a new look at banking laws might not win him friends on the Hill.

“Trump is the biggest wild card,” said David Settle, curriculum development manager at Investools®, TD Ameritrade's education affiliate. “He’s not viewed as a Republican establishment guy, so he’ll have trouble passing things through Congress; he had trouble even getting [congressional Republicans] to endorse him. The relationship isn’t too friendly.”

Trump and Clinton have thrown barbs at the Trans-Pacific Partnership (TPP), a trade agreement among 12 Pacific Rim countries. A number of Democrats in Senate supported the deal, so even a Democrat-controlled Senate might tangle with Clinton on this one, as would a Republican-controlled Senate with Trump. “The Senate passes treaties and trade legislation, so TPP is very important,” Stovall said. A pullback on trade deals like TPP could potentially hurt many multinational companies that rely on exports.

Both candidates have called for renewing the Glass-Steagall Act, a Depression-era law that restricted affiliations between banks and securities firms. President Bill Clinton and Republicans in Congress loosened those rules in 1999. Any attempt by either candidate to tinker with the law could face opposition in Congress, particularly if Republicans still control the House. The financial sector would be the one affected by any change in banking laws.

And both candidates also propose infrastructure spending, which may have a better chance with Congress, because so-called “pork” spending can help representatives with voters in their own districts, Stovall said. For instance, a Republican Congress worked with President Obama to pass a five-year, $305 billion transportation bill in late 2015. More spending on infrastructure could potentially help the industrial sector.

What About Possible One-Party Rule?

If one party does “run the table” in this election and takes the presidency and both houses of Congress, legislation could ramp up at a higher pace.

“Look at when Obama got elected and we had a Democratic Congress, and they passed things,” Settle said.

Stovall said that historically, the stock market tends to do best with unified political leadership.

In 2009 and 2010, when Democrats ran Congress and the White House, a huge amount of legislative work got done, with nearly three dozen major laws passed, including the Dodd-Frank banking bill, the Affordable Care Act (ACA), an $800 billion economic stimulus package, and comprehensive sanctions on Iran. All that activity in Congress corresponded with a big rally in the stock market, though that arguably was more a reflection of recovery from the 2008 to 2009 recession.

An activist Congress and President might get together on legislation and make lots of new laws, but in the long run, other factors are more likely to influence the stock market, analysts said. Earnings almost always take precedence, and monetary policy from the Fed could also have a big impact.

“This market is governed by the Federal Reserve, not Washington, so what happens with monetary policy will ultimately be a stronger driver of the equity market here over the near- to intermediate term than what happens in politics,” O’Hare said.

S&P 500, Congress, and elections

FIGURE 1: D.C. DIVIDED WE RISE.

The S&P 500 (SPX), plotted here over the last four years on the TD Ameritrade thinkorswim® platform, has risen 52% since the beginning of 2013, a time that corresponded with division in Washington. Source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

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