"Stocks love gridlock." So declares Forbes magazine in a recent column, highlighting the fact that when politicians in Washington are too busy campaigning for reelection to pass any laws... stocks tend to prosper.
And true to form, this election year, U.S. stocks have done just that. Even in a year dogged by sovereign defaults, and threats so to do, anemic job growth in the U.S., and turmoil in the oil-rich Middle East, the Dow Jones Industrial Average had clocked a 10% gain before hitting its recent turbulence, and had come within just a few hundred points of its all-time high. Even after falling back a bit, stocks sit comfortably higher than at the beginning of 2012. But what about 2013?
Gridlock forever
While Forbes holds out high hopes for Republicans gaining seats in the Senate, and whittling away at the Democratic majority there, Barron's magazine counters that, regardless of whether it's Mitt Romney or Barack Obama who wins the White House, "the 113th Congress [will remain] divided along the lines of the 112th, with Republicans controlling the House and Democrats controlling the Senate."
No return to the 2009 filibuster-proof Democratic supermajority is in the cards. Democrats aren't likely to retake the House, either. Nor will Republican gains in the Senate (if they gain at all) be great enough to give a newly elected Romney his own filibuster-proof majority.
So basically, we're headed for at least two more years of gridlock.
Good news?
According to an infographic recently prepared by Fisher Investments, when a Democrat is reelected, the S&P 500 returns 14.5% in the first year of his second term. Returns for a newly elected, first-term Republican president are even better -- 18.8% on average. When you combine these numbers with the historical benefits of gridlock (for stock prices, at least), investors may have a lot to look forward to in 2013.
The possibilities are rich enough to make an investor drool. A gridlocked Congress, unable to pass sweeping cuts in defense spending, alongside a president who's either gone on record saying sequestration "will not happen," or one who actually wants to increase defense spending? That could be great news for defense contractors like Boeing (BA +0.89%) and Lockheed Martin (LMT +3.48%).
On the health care front, the path to Obamacare has already been mapped out well into 2014 at least. That could give insurers like UnitedHealth (UNH +0.61%) and WellPoint (WLP 8.10%) a couple years' breathing room to figure out how to make a profit under the new insurance regime -- barring the threat of new regulation to repeal, tweak, or expand the program.
Similarly, a Congress too busy infighting to think up new ways to siphon profits out of the financial industry, to subpoena CEOs or monkey around with interchange fees, might open a window of opportunity for JPMorgan Chase (JPM 0.91%) and Bank of America (BAC 0.02%). Finally, an opportunity to sit down, study the new regulations, and start going after profit wherever it remains to be found.
Reality check
On the other hand, we've been here before, right? After a politically omnipotent President Obama failed for two years to pass the majority of his agenda, despite possessing a House majority and filibuster-proof Senate, Congress devolved into split-party gridlock in 2010. And what happened then? While legislators were unable to pass as many laws as they might have liked, by the same token, they were unable to take needed action to cut spending and reduce the deficit. The result was a financial crisis in which the United States of America very nearly defaulted on its debts.
That debacle didn't do much good for anybody, least of all investors, who in one particularly atrocious quarter (Q3) saw 14% of their portfolios vaporized by Congressional inaction.
Keep hope alive
So... which scenario will play out in 2013? The "historical" pattern of generous gains in stock market value, or the more recent example from history, that we call the "debt ceiling crisis?"
Bernadette Budde, senior VP for political analysis at the Business Industry Political Action Committee, believes legislators have finally come to "an agreement among Republicans and Democrats that the Simpson-Bowles deficit-reduction plan needs to be revisited." She's convinced that shortly after the election, a grand bargain will be reached to reduce the debt and fix the nation's fiscal problems.
Such a bargain will include "tax reform" and a reduction in tax rates -- presumably alongside the closing of loopholes, and hopefully, a return to historically ebullient stock markets, regardless of who's in the White House.
Here's hoping compromise and common sense trump gridlock. Here's hoping she's right.
