The political tensions in Washington are bad news for the Trump rally
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In light of the failed attempt to repeal and replace ObamaCare, the talk of political gridlock is heating up. This is certainly a different kind of gridlock, as the Republican Party controls the presidency, the House, and the Senate. Yet, it seems that political gridlock exists because of distinct factions in the Republican House, including the far-right Freedom Caucus and the center-right Tuesday Group, and the political inability or unwillingness to reach across the aisle to moderate Democrats.

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My area of expertise is financial markets, and with respect to political considerations, the conventional wisdom is that “political gridlock is good for the markets.” This mantra is often repeated in the financial press, particularly around the time of elections.

 

In 2010, Forbes columnist, money manager and author, Ken Fisher wrote, “Look forward to the gridlock of the coming year, because little gets accomplished. If you hate politicians as much as I do you’ll find this quite marvelous.” Last year on Bloomberg Television, Jason Pride, director of investment strategy at Glenmede Investment and Wealth Management indicated that a modest amount of gridlock tends to be the best for economies and the markets. The theory is that significant fiscal policy actions, which tend to disrupt the markets, are more likely to occur during political harmony rather than gridlock. Theories are great, but what does the evidence suggest?

Along with Scott Beyer of the University of Wisconsin Oshkosh, Luis Garcia-Feijoo of Florida Atlantic University, and Gerald Jensen of Creighton University, I jointly analyzed stock market returns relative to the political party of the president, the Federal Reserve’s monetary policy, the year of the president’s term and the state of political gridlock (that is, if the presidency, the House, and the Senate were under one party’s control). The research considered all of these variables together, and the findings were published in 2015 in the academic journal Managerial Finance.

What we found was that considering those four variables all at once, political harmony (the executive branch, House and Senate all controlled by the same party) is actually better for the stock market than gridlock. We also found the political party affiliation of the president was the least important and that investors generally have to wait until year three of a president’s term to experience the highest returns. Even after controlling for Fed policy, political gridlock and the party of the President, there is an unexplained “third year effect.”  

The research shows that, without question, the most important factor is Federal Reserve monetary policy. Historically, stock returns are markedly higher when the Fed is pursuing an expansive monetary policy than a restrictive policy and that factor overrides political considerations. It seems that all of the attention recently paid to Fed actions and inactions is truly warranted. Whether under Republican or Democratic administrations, the Fed has a significant influence on market returns, and Fed policy shifts are signals of coming inflationary pressures or other economic trends that impact markets.

The good news for the Beltway is that the empirical evidence refutes the cynical view that the best state of affairs is a divided government. It turns out a little collaboration and agreement can be good for investors and the Trump rally after all. Can’t we all just get along?

Robert R. Johnson, PhD, CFA, CAIA, is president and CEO of The American College of Financial Services. He is co-author of Strategic Value Investing, Invest with the Fed, and Investment Banking for Dummies.


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