What does divided government mean for the market?
Stovall studied the performance of the S&P 500 from 1900 until this year under three scenarios: total unity (one party controlling the House, Senate and White House), partial gridlock (one party controlling both houses of Congress and the other controlling the White House), and total gridlock (a divided Congress).
Over all years, the S&P rose at a 6.8 percent annual pace. During times of total unity, 67 of the 111 years analyzed, it gained 7.6 percent annual pace. During times of partial gridlock, accounting for 32 years, they gained 6.8 percent. And during the 12 years of a gridlocked Congress, the S&P gained just 2 percent per year. Looking at more recent years, since 1945, the pattern holds. Under total unity, stocks climbed at a 10.7 percent annual pace. Under partial gridlock, they gained 7.6 percent per year. And under total gridlock, which accounts for eight of the 65 years, they gained just 3.5 percent per year.[...]
But Stovall only looked at the S&P 500. What about the market as a whole? Scott Beyer of the University of Wisconsin-Oshkosh, Gerald Jensen of Northern Illinois University and Robert Johnson of the CFA Institute examined broader market returns in a 2004 article for the Journal of Portfolio Management.
Like Stovall, they found that big-company stocks suffer during times of gridlock — returning 0.8 percentage points less than during times of unified government. But gridlock really hurts small stocks — the equity of little companies with less ability to adapt. During times of unity, they returned an annualized 23.5 percent. During times of gridlock, they returned 11.4 percent per year.
She also notes that polls of market participants show they want Republicans and Democrats to "cooperate" going forward. It's a good reminder "that 'the markets' are in reality 22-27 year old business school graduates," and their take on politics is no more or less prescient than you'd expect from that profile. Like most voters, they get excited when elections come around, as they overestimate the likelihood that the politicians they support will not just make major changes, but make the specific changes that they (in this case, "the market"), as opposed to the base, or the politician's favored special interests, want. Then some time passes and that hope is proven false and they settle into a period that's not just politics-as-usual, but the sort of politics-as-usual where nothing gets done.
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