Stocks Rally as Wall Street Bets Washington Gridlock Will Stymie Democratic Agenda

The stock market's recent run may suggest that investors believe the prospect of a divided government is good for business—and their portfolios.

Joe Biden, likely to be confirmed as the next president, campaigned as a moderate in the Democratic primaries, resisting pressure from the left wing of his party to embrace reforms such as the Green New Deal, Medicare for all and a wealth tax.

After a dramatic drop early in the pandemic, stocks lately have been booming (here, the New York Stock Exchange). JOHANNES EISELE/AFP/Getty

However he has promised to increase corporate taxes and income taxes on the wealthiest households, expand the protections of the Affordable Care Act and deal with climate change by eventually weaning the United States off fossil fuels. Many of these changes will be more difficult to push through if Republicans control the Senate as they are now expected to do.

If Joe Biden becomes president, and if the Senate remains in Republican hands, as now appears likely, investors appear to be betting that divided government means no large tax hike, no major increase in environmental or financial regulations and no Green New Deal.

"History is a great guide, but it's never gospel," Sam Stovall, chief investment strategist at CFRA Research in New York and author of The Seven Rules of Wall Street, told Newsweek.

"Wall Street is adaptable," Stovall said. "It will always attempt to find a way to make money whether there's a Democrat or Republican in the White House or whether the president is backed by a unified Congress or opposed by the other party."

The three major stock indexes, Dow Jones Industrial Average, Nasdaq and the S&P 500, rose Thursday and are on track for their best week since early April.

Stock market returns by party, election day to election day, were higher under Democrats (9.4%) than Republicans (6.5%). But four Republican presidents posted double-digit increases during their terms in office compared to only one for a Democrat.

In the 76 years since 1944, the government has had three basic configurations: Unified government, where the White House and Congress were controlled by the same party; united Congress, where a president from one party was opposed by a unified House and Senate controlled by the other party; and a split Congress where the House and Senate were controlled by different parties.

"General George S. Patton said, 'Lead me, follow me, or get the hell out of my way'— and a split Congress is essentially getting out of the way," Stovall said.

Stovall said the best calendar-year average returns —13.6% —were posted under a split Congress with a Democratic president.

The S&P 500 rose an average of 10.6% in 30 years of unified government compared with an average of 8.8% for all 76 years, Stovall said. But a unified Congress of the opposite party returned only 7.4% compared with returns of 8.6% under a split Congress.

The S&P 500 posted the highest compound annual growth rates under Democrat Bill Clinton (+16.5%), Republican Donald Trump (11.24%) and Republican George H.W. Bush (11.19%).

The weakest returns came under Democrat Jimmy Carter (+5.8%), Republican Richard Nixon (-4.0% and George W. Bush (-4.3%), Stovall said.

Growth during a president's term in office may also be telling.

"The strongest growth in earnings per share was seen during the Obama years as companies recovered from the financial crisis," Stovall said. "The second strongest period occurred under President Clinton, possibly due to the 'peace dividend.' The third best was under Harry Truman in response to the post-war economic boom."

Due to recessions or economic slowdown, the weakest share growth occurred under Bush-41, Bush-43 and Trump. But Stovall noted the data underscore a disconnect between stock market returns and U.S. economic growth.

Real gross domestic product grew the most under President John F. Kennedy and expanded strongly under Truman. The weakest economic growth occurred under father and son Bush and Trump.

But this may not tell the entire story.

"All presidents endured economic and market downturns, some more than others," Stovall said in a research report.

"Presidents Nixon and Bush-43 had their terms in office booked ended by recessions, while (Dwight) Eisenhower had to deal with three, Stovall wrote. "In fact, every elected Republican president since Chester A. Arthur (in office 1881-1885) had a recession at the start of their first term in office while four Democratic presidents witnessed none."

Truman, Lyndon Baines Johnson had two bear markets — a drop of 20% or more from a recent high — while Truman, Ford, Clinton and Obama endured three corrections, or dips ranging from -10% to -19.9%.

Clinton served as president during the best overall stock market performance, but there wasn't a bull market during his two terms in office. However, Truman and Ronald Reagan had two each.

"Is all of this data statistically significant? Do we have enough observations to make analysis?" Stovall asked rhetorically. "Most statisticians say you need at least 60 observation points – and remember that 40% of statistics are wrong."

Others share Stovall's view of government and the market.

"The market is assuming that at least one branch of government will remain in control of the Republicans and this will tone down tax increases, new EPA rules and the Green New Deal," Manish Shah, CEO of Tollbooth Strategy in Miami Beach, Florida, told Newsweek.

Shah said the upcoming stimulus is the most important factor in future projections.

"The real impetus to the market is the expected size and the nature of the new stimulus," Shah said. "If Democrats control more levers of power, there will be larger stimulus directed to the individuals and local and state governments, and if the Senate is still in GOP control, then at least some of the stimulus will be directed to businesses."

The economy continues to regain its footing after the coronavirus shutdown last spring intended to curb spread of the coronavirus. On Thursday, the Federal Reserve, the nation's central bank, held its benchmark interest rate at 0-0.25%. It has been at that level since March in the early days of the coronavirus pandemic.

"Economic activity and employment have continued to recover but remain well below their levels at the beginning of the year," the Federal Open Market Committee (FOMC) said in a statement released at the conclusion of its two-day meeting.
In September, the FOMC said economic activity had "picked up in recent months."

Speaking about politics and Wall Street, Mark Twain famously said, "History doesn't repeat itself, but it often rhymes."