The people have spoken (at least those who voted), and 2023 and 2024 will be host to a divided government. The conventional wisdom is that a divided government is a good thing for markets. That’s not always, or even often, the case.
In inflation-adjusted terms, the S&P 500 Index returns are, on average, higher when there is a unified government (9% when unified under Democrats’ control and 13% when unified under Republicans’ control) than when there is a divided government (6%). Although our data go back to 1870, there are so many wild changes in the economy, and even in the platforms of the political parties, that these averages might not be that meaningful.
When thinking about what the election means for markets, consider the economic context and then consider what types of policies may or may not be changed. The economic context isn’t all that great. Yes, the labor market is very strong, for now. Growth has been erratic, but it’s slowing. Inflation has been intense. The Federal Reserve (Fed) has been hiking furiously. International conditions are challenging.
A perspective based solely on the economic context and the likelihood that we will see a Fed-induced recession in the U.S. sometime soon would argue for caution. However, if there is a recession, it will likely be one of the clearest-telegraphed recessions ever. Markets are forward looking, and nobody should be surprised that rapid rate hikes and a war in Ukraine will likely cause a recession. From our view, that’s probably why yields have gone so high and equity markets are well below their early-2022 peak. The market is already pricing in some economic pain ahead. Has it priced in enough? In some parts of the market, we think it has. This calls for doing due diligence on investments instead of just owning whatever the market throws out there.
What about the types of policy changes that may or may not happen? That’s where it gets more fun for those who are passionate about politics. The chart below shows when there was a unified government under Democrats’ control going into an election and then the two possible outcomes coming out of the election: a divided government with Republicans in control of at least one of the chambers of Congress and the status quo, where Democrats retained control. There aren’t a lot of observations to draw firm statistical conclusions. Plus, the contexts (economic and international) were so varied that those economic and international factors probably mattered more than anything that happened in Washington. Sometimes transitioning to a divided government can be awesome for the markets. Sometimes not.
With a divided government, Republicans might try to use the debt ceiling and the budgeting process to disrupt any further advances of President Biden’s agenda. It could look like the 2011–2012 period, when we had government shutdowns and debt ceiling brinksmanship. For those who remember, 2011 was not a great time for the S&P 500 Index. However, was it due to U.S. politics? Probably not. That was the year “Grexit” became a word. People were afraid that Greece’s debt crisis was going to cause them to get kicked out of the eurozone and that there’d be a eurozone crisis.
Looking ahead, two things to watch will be the lame-duck session of Congress and the use of executive authority. The lame-duck session of Congress just refers to the period between the election and when that outgoing session of Congress finally adjourns. Given the erosion over time of the filibuster rules in the Senate, it’s possible that we could see the filibuster further weakened in order to pass a flurry of pieces of legislation to raise the debt ceiling, change taxes, and advance social and climate programs that are near and dear to the Democrats’ hearts. While a possibility, it does seem highly unlikely. Moderate Democrats who represent politically divided areas might not agree to such a plan. Besides, those types of tactics are bad optically, and the 2024 presidential election is right around the corner.
In modern politics, the president has a lot of authority—within bounds—to interpret and choose how to enforce certain rules and regulations. The key is that this power is “within bounds.” President Biden has interpreted laws in a way that causes him to believe that he can forgive student loan debt. That’s a novel point of view, and there are lawsuits testing whether this interpretation is correct. He may continue to test whether he has the authority to do other things, but we don’t expect many radical changes.
With the mid-terms behind us, I guess we can start looking forward to the 2024 presidential election. Navigate these markets judiciously, but don’t let personal political biases distract you from your longer-term goals.
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