In this time of great political divide, the one thing on which there seems to be broad agreement is that divided government has generally worked better for financial markets than one-party control. In the aftermath of the highly contested 2020 election, investors seemed to take solace in the belief that divided government would create the type of political gridlock that historically has tended to propel markets higher. The fact that US equity markets advanced nearly 11% in November 2020 and ended the year at record highs1 seemed to affirm the value of political checks and balances.
As the late great sportscaster and Georgia’s own Keith Jackson would say, “Hold the phone!” The polls appear to have tightened in the Georgia Senate special elections, and the oddsmakers now have the elections as virtual dead heats. Control of the Senate and investor expectations of divided government hang in the balance.
What could the results mean for investors?
Investors can’t be blamed for feeling a bit of déjà vu as they are left once again to grapple with the potential implications of this election. Could today’s special elections lead to additional fiscal spending, higher corporate taxes, changes to the Affordable Care Act, and more? On the opening day of 2021, the Dow Jones Industrial Average declined nearly 400 points, which couldn’t have helped to ease investor concerns.2 Now what?
Lest investors get too uneasy, let’s remember that the markets performed just fine during the last two instances of unified government:
The S&P 500 Index returned 54% from the day Barack Obama was inaugurated in 2009 with Democrat single-party rule to the day of the 2010 midterm election “shellacking” (Obama’s word, not mine), when voters once again opted for a divided government.3 Markets also returned 25% under Republican single-party rule from Donald Trump’s inauguration day to the 2018 midterm election, when the Republicans lost control of the House.4
Market tailwinds remain in place
The same notable market tailwinds that we saw in 2009 — economic recovery, 0% interest rates, massive monetary policy accommodations, fiscal support, stocks cheap to bonds,5 inflation tempered by heightened unemployment, and the economy running below capacity — are in place today. If the Democrats manage to pull off the upsets in Georgia, then a key difference this time around, in my view, is that many of those same Democrat players who were there in 2009 would likely use their latest opportunity to advance greater fiscal spending to support the economic recovery. In a more-pronounced economic recovery, we would expect an even further rise in Treasury rates, tightening of municipal and corporate bond spreads, weakening of the dollar, and higher performance of value stocks and emerging market equities. If the Republicans maintain control of the Senate and fiscal spending is tempered, then I would expect the economic recovery to be less robust and the value-oriented market recovery less pronounced.
As for renewed concerns about potentially higher tax rates derailing the market advance, the same was said in 2009 and 2010, during the Obama-Biden administration. Back then, tax increases were put on the backburner in order to not derail a nascent economic expansion following the global financial crisis. I would expect a similar approach under a Biden administration.
As for concerns that the policies of a unified Democratic government would be massively inflationary and crush market multiples — again, the same was said in 2009 and 2010. Today, the economy and markets are still facing deflationary forces. Note that the 10-year US Treasury rate has remained below 1%.6 We will assess again in the future, but I believe 2021 is unlikely to be the year to be concerned about taxes and/or inflation.
Admittedly, all of this could be for naught. Upset victories by the Democrats in the Georgia special elections are by no means a foregone conclusion. Divided government might win the day. Either way, the market tailwinds expressed above do not change.
The Georgia special election may feel like the Granddaddy of Them All, but with apologies to Keith Jackson, let’s keep it proper perspective.
1 Source: Bloomberg, L.P. Based on the S&P 500 Index.
2 Source: Bloomberg, L.P., as of Jan. 4, 2020.
3 Source: Bloomberg, L.P. Based on the S&P 500 Index. Returns are from inauguration day Jan. 20, 2009, to the midterm elections on November 2, 2010.
4 Source: Bloomberg, L.P. Based on the S&P 500 Index. Returns are from inauguration day Jan. 20, 2017, to the midterm elections on Nov. 6, 2018.
5 Source: Bloomberg, as of Jan. 5, 2020. Analysis compares the S&P 500 earnings yield to the 10-year US Treasury rate.
6 Source: US Department of the Treasury, March 5, 2020, to Jan. 5, 2020.
Blog header image: Mrolands/ Getty
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.
The Dow Jones Industrial Average is a price-weighted index of the 30 largest, most widely held stocks traded on the New York Stock Exchange.
The S&P 500® Index is an unmanaged index considered representative of the US stock market.
Spread represents the difference between the yield on a corporate bond or a municipal bond and a similar maturity US Treasury bond.
The opinions referenced above are those of the author as of Jan. 5, 2021. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.