Red, Blue or Both? Still A Bullish Scenario For Stocks

As I write this, former vice president Joe Biden has not yet been named president-elect, but with him leading in the crucial battleground states of Pennsylvania and Georgia, it looks more and more likely that he will be sworn in this January.

The market seems to have predicted this outcome. If the S&P 500 is up between July 31 and October 31 before an election, it has historically favored the incumbent party. And if it’s down, it has favored the challenger. Following a loss of 5.6% last week, the S&P was underwater about 4 basis points from the end of July.

Many of you reading this are no doubt disappointed. In a poll I ran back in August, 76% of you said you believed President Donald Trump would be better for the stock market than Biden.

I’m here to tell you there’s probably no need for handwringing at this point, especially since projections of a “blue wave” did not materialize. The Democrats were not able to flip the Senate, managing only to keep control of the House.

inflation is the trick gold is the treat

Investors were strongly in favor of this development, with the S&P ending the week up 7.3%. This is a very good sign for stocks for the rest of the month and year. According to my good friend Pimm Fox, “the direction of the S&P 500 did not change from the period beginning the day after the election for the remainder of November, nor for the rest of the year.”

If history is any indication, a Biden presidency and divided Congress may very well end up being the most favorable outcome for equities. With Republicans controlling the Senate, we’re less likely to see hugely consequential legislation passed such as massive tax hikes, drug pricing limits, nationalized health care and spending for the Green New Deal. Both chambers will need to compromise to pass another stimulus package. Other policy may continue to be made mostly by presidential executive order, which can easily be rolled back by the next president.

Businesses love Congressional gridlock for this very reason. Tech stocks had been trending down for days before the election as they faced antitrust scrutiny, but now that it appears certain Congress will remain divided, they’ve recovered most of their losses. The tech-heavy Nasdaq 100 jumped close to 10% for the week.

Focus on the Policies, Not Necessarily the Parties

Below is a chart I shared with you two years ago, after the 2018 midterm elections. Looking all the way back to 1928, average annual stock returns were highest (16%) when there was a Democratic president and split Congress, according to Bank of America (BofA). One caveat: This particular setup has a very small sample size, seen only in the last four years of President Barack Obama’s eight-year administration.

Stock markets have
click to enlarge

The largest sample size is when there was a Democratic president and Democratic Congress, seen in 34 out of 89 years. During those years, average returns were a still attractive 14%.

The reason I point that last part out is because you may be wondering about the ramifications should Democrats take full control of Congress in 2022. By my count, 22 Republican senators will face reelection that year, giving Democrats an opportunity to flip the upper chamber.

As I frequently say, it’s not the party that matters, but the policies. We believe government policy is a precursor to change, and that money can be made in America no matter who’s in charge. Case in point: Stocks recovered nicely in Obama’s first term following the housing market crash, despite there being a legislature controlled by Democrats. Health care stocks, in particular, were big winners between January 2009 and January 2013, rallying more than 80%.

Inflows into gold-backed ETFs increased for an 11th straight month
click to enlarge