And the Winner is… America From the Deep Woods

In the fantastically entertaining, although mostly unrealistic, modern film classic, “Wall Street,” the unforgettably unctuous villain Gordon Gekko famously made a speech where he proclaims, “Greed is good.”

Today, I’ve decided to channel my inner Gekko and make a similar proclamation regarding midterm election results, and it is… “Gridlock is good.” Yes, gridlock in Washington is back, and that means that the real winner this morning is America.

I say that because through my libertarian-tinted glasses, the less that “gets done” in Washington, the better. Stated differently, the fewer new laws that rob Americans of their liberty and their property, the better off everyone will be.

With the Democrats soon to be in control of the House of Representatives, and the Republicans still firmly in control of the Senate and the White House, we have a potent prescription for gridlock of the sort that freedom-loving Americans should embrace.

What gridlock means in today’s context is no threat to the Trump tax cuts.

Unfortunately, it means no further tax cuts are likely, but further tax reform isn’t what most experts thought was on the agenda anyway.

Gridlock also likely means no big spending legislation over the next two years. The one caveat here comes if Democrat and Republican leaders get together with President Trump to pass some big-government infrastructure spending bill. A huge infrastructure spending bill means a lot of debt, and likely a lot of inefficient use of our tax dollars.

For Wall Street, at least historically, gridlock has been a very good thing. An article today at MarketWatch cited some eye-opening statistics from Bank of America showing that since 1928, stocks in the S&P 500 have produced an annual average return of 12% in years when a Republican president held office and Congress was split.

That research also showed that in the year following a midterm election that resulted in a Republican president and a split Congress, returns for the S&P 500 have averaged more than 20%.

The data here shows the historical validity of my “Gridlock is good” thesis, but the reason why I think markets are in a good position going forward this year is because now markets can get back to focusing on what really matters — i.e. fundamental drivers of equity prices such as corporate earnings growth, economic growth and monetary policy.

So far, corporate earnings growth continues to be strong, and that’s despite the relatively high number of high-profile earnings and outlook disappointments we saw in Q3.

Moreover, broad macroeconomic data continues to be strong (GDP growth, employment data, sentiment surveys) despite a few points of weakness (housing, building permits).

As for monetary policy, the Federal Reserve’s Open Market Committee (FOMC) just happened to begin its two-day policy meeting today. And while no change in interest rates is expected this month, what the markets want to see is if there will be any alteration to the “hawkish” rhetoric we’ve been hearing for the past couple of months.

Recall that one of the reasons for the equity market volatility in October was the hawkish comments from Fed Chair Powell, when he said that rates were likely a “long way” from neutral, implying a lot more rate hikes to come. If the Fed fails to mention the recent volatility in stocks in tomorrow’s FOMC statement, markets will perceive that failure as the Fed remaining very hawkish.

Finally, there is one more seasonal trend that deserves mention here that isn’t even correlated to the “Gridlock is good” thesis, but that nevertheless happens to be true an amazing 100% of the time.

This indicator was brought to my attention by Tom Essaye of the Sevens Report, who cited research showing that since 1946, there have been 18 midterm elections. And, in the 12 months following each of those elections, the stock market has rallied sharply. In fact, Tom shows that fully 100% of the time, stocks have been higher 12 months after a midterm election by an average of 17%.

Additionally, the average gain from the lows of the year during the midterm (so today that means about 2,530 in the S&P 500) was 32%. And as Tom points out, “Those two numbers equal 3,223 in the S&P 500 (a 17% gain from Tuesday’s close) and 3,340 (a 32% move from the 2,530 2018 low). So, not only is gridlock good — but for markets, the 12 months after the midterm also happen to be very good, 100% of the time!

I don’t know about you, but to me, that sounds like America is the real winner today.