The elections are over and we have a divided Congress.  Republicans have taken control of the House and Democrats still have more seats in the Senate (though not a super majority), which suggest that there will be political gridlock.  Conventional wisdom holds that divided government is good for the stock market, but research suggests that may not be true.

Sam Stovall, the chief investment strategist for Standard & Poor’s Equity Research Services, finds that gridlocked Congresses can hurt the markets.  Stovall studied the performance of the S&P 500 from 1900 until this year under three scenarios.  I’ve laid out the results of all scenarios in the table below.

The average annual gain in all scenarios from 1900 to present was 6.8%.  During times of total unity, the S&P 500 had an average annual gain of 7.6%.  During times of partial gridlock, the S&P 500 posted an average annual gain of 6.8%.  During times of a total gridlock (like our new Congress), the S&P 500 returned an average annual gain of just 2.0%. 

One may conclude from this data that total gridlock hurts stocks by causing uncertainty – divided governments do not lay out their priorities and the resulting uncertainty may hinder stock performance.   Of course, it is possible these results are simply the result of coincidental correlation.  Nevertheless, the data challenges conventional wisdom that a divided Congress is good for the stock market.

The average investor should think twice about making adjustments to their portfolios purely in response to election results.  The election is just one of many factors that influence the economy and the performance of markets.  And with the economy becoming increasingly global, the actions of a single government are less important.

Investors may be viewing the newly divided Congress through rose-colored glasses.  The markets seem to be anticipating a reauthorization of the Bush tax cuts, but they could be seriously disappointed if this doesn’t come to fruition.  In addition, Republicans may be inactive in legislating but will be seriously active in defunding or attempting to repeal Obama’s legislative successes – introducing a lot of uncertainty into already-shaky markets.  The markets might not be taking the full impact of such chaos into account.

Thanks for reading.

Peter Lazaroff, Investment Analyst

www.acrinv.com