Stocks could get a choppy ride with this flavor of divided government
The political landscape in Washington is set for the coming years with Democrats in control of the White House and Senate, while Republicans will control the House of Representatives.
Investors and business leaders often look forward to periods of divided government, but — if history is any guide — this gridlock may be far from a major stocks win over the next 12 months.
The last time the United States had this particular flavor of split control, which occurred from 2011 through 2016 — the S&P 500 returned 5.9% in the 12 months following the 2010 midterms and 3% after the 2014 elections, far lower than the returns after other divided midterm results.
Still, the larger historical lens shows that chaos in Washington rarely matters in the long term.
The case for worry
Usually, the 12 months following midterm elections are great for stocks. A U.S. Bank report recently noted “uncertainty resolves after the midterm election” and gains can follow. The researchers crunched the numbers since1962 and found that the stock market tends to “underperform in the 12 months leading up to midterm elections and overperform the 12 months after.”
The last time stocks declined in the 12 months following a midterm was during the Great Depression. Stocks even went up slightly between Nov. 1, 1986 and Oct. 31, 1987 — an era that featured the historic stock market crash of 1987.
In more recent history, two of the lowest performing post-midterm periods immediately followed those 2010 and 2014 midterms. That's when Americans voted for a divide very similar to where things stand now. Barack Obama, a Democrat, was in the White House with then-Sen. Harry Reid (D-NV) in charge of the Senate. Meanwhile, Republicans controlled the House under Speaker John Boehner (R-OH).
A key driver of many of the market declines back then were of Washington’s own making — in particular the brinksmanship over the debt ceiling.
The debt limit brinkmanship had a direct impact on stocks that year — as well as outside factors like a debt crisis in Europe — leading to stocks falling 12% at one point as Standard & Poor's downgraded the United States' credit rating for the first time in history. In the end, stocks ended calendar year 2011 almost exactly flat with the S&P 500 closing on Dec 30, 2011 at 1,257.60 after opening the year at 1,257.62.
This time around, it’s the same setup but with a different cast of characters. There is President Joe Biden, Senate Majority Leader Chuck Schumer (D-NY), and possible House Speaker Kevin McCarthy (R-CA). Lawmakers also appear set for another round of debt ceiling brinksmanship in 2023 with some observers worrying it could be even uglier this time around.
“I think what we'll probably find out next year is gridlock was not good" Charles Myers, founder of Signum Global Advisors, recently told Yahoo Finance. He added that credit agencies may be quicker to offer downgrades this time around if the debt ceiling issue isn’t resolved quickly and the resulting chaos could spill beyond equities and into Treasury bonds and even the U.S. Dollar.
While stocks also had a below-average year in the 12 months following the 2014 midterm elections, the main factors that held prices down in that era — a collapse in oil prices and a slowdown in China — were largely not the doing of lawmakers in Washington.
The case for optimism
In a note previewing what to watch in 2023, the commentators at LPL Financial said they “expect the impact of the election to tilt the market positive, partly because we’ll have it behind us.” A more important factor to watch in 2023, they added, is not Capitol Hill but the Federal Reserve’s ongoing fight against inflation.
And while the market may be in for another bumpy ride in 2023, investors should look beyond the next 12 months.
Edelman Financial Engines recently compiled a report for their clients of all the different flavors of divided government and found that — over a long enough timeline — the returns largely evened out. In fact, there is good news for investors still reeling from a choppy 2022; the returns with a Democrat in the White House are historically well above average no matter what is going on the other side of Pennsylvania Avenue.
In fact, even in those chaotic years from 2011 to 2015, investors who stayed steady through the ups and downs made out with 15.9% annual returns over the entire four-year period, according to the Edelman data.
As the company's Director of Financial Planning, Isabel Barrow, told Yahoo Finance Live in a recent appearance: “Ultimately, what we found was that no political party substantially impacted long-term market returns.”
Ben Werschkul is a Washington correspondent for Yahoo Finance.
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