How Will Political Gridlock Impact the Markets?

Midterm elections make investors nervous. Results tend to be disruptive, leading to a spike in market volatility around the time of the election.  In each of the last four midterms, the incumbent president’s party has lost control of one or both chambers of Congress. It just happened again. Should we fret over political gridlock and its impact on the economy and markets?

Probably not. Though the election’s outcome will certainly impact policy decisions, the outlook for the economy remains largely positive. Interestingly, political gridlock can often prove positive for the markets. It helps temper wild swings in fiscal and regulatory policy, calming investor nerves. According to global asset management firm AllianceBernstein, since 1928, the S&P 500 index has generated double-digit annual returns when Democrats and Republicans have shared control of Congress, with a Democratic president and a split Congress offering the best outcome.

While gridlock may be beneficial at times, study after study has shown that political outcomes generally don’t drive financial markets. The relative health of the economy is what matters most, and it rarely corresponds to any particular mix of political leadership. As boring as it sounds, investors would be wise to cool their heels until the current noise dies down a bit. Taking the long view and sticking to your current investment plan will usually deliver a better outcome than changing strategy based on your take of the current political leadership.

Still, it can be useful to consider what the new leadership might accomplish over the next couple of years. Many prognosticators have suggested that a bipartisan Congress could develop a reasonable plan for infrastructure spending. If that happens, it would no doubt provide an economic boost, but it could also strain the growing budget deficit.

Some commentators expect further tune-ups to the retirement system, including making 401ks more accessible for small businesses while easing the enrollment process for those entering the workforce.  It would be unrealistic, however, to expect significant legislation to be passed between now and 2020.

Further tinkering with the Affordable Care Act and talk of additional tax cuts will no doubt come to a screeching halt, at least for now. In the meantime, politicians will need to take a much-needed break from partisan vitriol, since they now need to reach across the aisle to get anything done. Stay tuned.