This question is being asked a lot following last week’s midterm election results, in which the Republicans held onto the Senate and the Democrats claimed control of the House. In one sense, these results may not matter for U.S. stocks.
As shown in LPL’s Chart of the Day, stocks historically have performed well after midterm elections regardless of the results, with gains in 18 consecutive 12-month periods. Investors like the removal of political uncertainty, and, typically after losing seats in Congress, presidents try to boost their re-election chances after midterms with pro-growth initiatives.
On the other hand, even if gridlock matters for stocks, it’s probably more positive than negative. A Republican president with a split Congress historically has been one of the best combinations for the S&P 500 Index, with 15.7% gains on average in this scenario. Investors tend to like checks and balances that can take extremes out of play and maintain the status quo. We do not expect House Democrats to meaningfully change the path of fiscal stimulus or deregulation in 2019, which is likely still bullish for stocks.
So can the President work with a divided Congress to get anything done? Perhaps. One area of potential compromise is on infrastructure. Republicans probably won’t support repealing a portion of their tax cuts to pay for it, but a small package is quite possible. We see this as a potential positive for the industrial and materials sectors. Drug pricing is another area with bipartisan support, which may introduce headline risk for big pharmaceuticals and biotech. Democrats could offer defense spending to encourage Republicans to increase medical research spending through the National Institutes of Health (NIH).
“Regardless of how policy plays out, we welcome the market’s ability to focus on fundamentals now that the election has passed,” said LPL Research Chief Investment Strategist John Lynch. “Those fundamentals are quite positive, including solid U.S. economic growth, fiscal stimulus, deregulation, record corporate profits, low interest rates, and manageable inflation.”
Trade is a risk, but keep in mind that trade is a relatively small part of the overall U.S. economy, and that tariffs—proposed and implemented—amount to much less than the amount of fiscal stimulus implemented earlier this year.