Questioning the theory of investor preference for political gridlock

"There is never 'one thing' for the market."

One theory making the rounds of late is that wealthy investors would have preferred more split government to a Democrat sweep in election 2020. A so-called blue wave would have been reason for concern, given that it would raise the chances of impending tax hikes (among other things).

However, this preference was not echoed by the markets once the election cycle finally came to its conclusion, indeed in Democrats’ favor. Quite the opposite occurred January 6-8 as first Georgia’s senatorial runoff results, and then Congressional affirmation of Biden-Harris, were met with risk-on rallies.

Certainly, there are salient historical examples where political gridlock proved desirable, more generally. The absence of gridlock could clear the way for one party to execute its full agenda, which by nature can alienate (and possibly even harm) entire portions of the population.

Yet, the notion that the wealthy always prefer a split government to single-party dominance seems more like confirmation bias in action than careful analysis of present circumstances. Not only is it not being borne out at this juncture, but the historical record indicates that markets have actually swung to the upside when the policies bolstered by a blue wave materialize. Hence, how seriously should we take the theory?

For the last couple of years, Pelosi and the Democrats held down the House, while the Republican majority Senate and White House tried chipping away at various GOP objectives. At stake were issues such as the ACA, immigration, corporate taxes, trade, and SCOTUS appointees. Had the Republicans controlled the House as well, some things would surely look different today.

As speculation mounted that the shoe could end up on the other foot, concerns were voiced in the event that the Democrats should win too much, including: impending tax hikes, heavy-handed government regulation, fiscally precarious and burdensome spending on extensive social welfare, and some vague giving away of the country to the somehow undeserving, among other things.

All sides expected McConnell to be the one standing in the way, still backed by a Republican Senate majority, taking the baton from Pelosi and the House Democrats. That is, before wins by Warnock and Ossoff effectively put the entire legislative branch in Democrat’s hands, what with Congress expected to affirm Biden-Harris later that day (and seal the deal on the executive branch, as well).

Presumably, the markets should have sputtered accordingly.

Yet on that Wednesday, January 6, the markets did anything but sputter. The DOW, S&P, crypto, and crude moved up, yields climbed, and gold and tech declined. The DJI alone leapt nearly 500 points. Those were risk-on/safe-haven-off moves punctuating approval of the full election outcome, and were particularly striking given that an insurrection was unfolding in D.C. with time left in the trading day for the markets to really stumble.

They didn’t. The rallying continued into Thursday as Biden-Harris were finally affirmed by Congress—this time with the NASDAQ coming along for the ride in a big way—and carried over through Friday.

Why would that be? The simple answer is that for everyone involved, the pros outweigh the cons.

There is never “one thing” for the market. There are too many moving parts to hold all else equal.¹

~Denise Chisholm, Fidelity sector strategist

A more detailed explanation is that resting on Biden-Harris taking office is the possibility of further fiscal stimulus, the perception of future stability, improved and more responsible management of the ongoing health crisis, sensitivity to marginalized groups, potentially less corruption and abuse of power across the board, and the normalization of global political relations, among other outcomes. A Democrat sweep amplifies the above possibilities from which we may all benefit.

Trump, on the other hand, represents a failed state. All the anachronistic fear in the world that might accompany a blue wave—over unrealized regulatory activity, tax hikes, threats to generational wealth transfers, a future where the country is sinking in an ocean of social welfare and overrun by outsiders and criminals—may be overshadowed by all there is to gain from life after Trump.

In fact, limiting the conversation to impending tax hikes alone, research indicates that equities have done well the year preceding, as well as the year of, past tax hikes. What's more, this was the case 100% of the time that corporate and personal tax rates were the ones to be raised. Per Fidelity:

What does history say? In the 13 previous instances of tax increases since 1950, the S&P 500, the stock index that tracks most of the major companies in the US, has shown higher average returns, and higher odds of an advance, in times when taxes are increasing, according to Chisholm's research, which analyzed the data in the calendar year of the tax changes, plus the year prior and year after. This holds true even when you drill down into key sectors of the S&P 500.¹

Reasons for the outperformance include any stimulus spending that was also happening at the time. In a word, tradeoffs. If the historical record is anything to go by, investors today actually have more to look forward to than to fear.

That, and such fear is overblown.

As if Democrats themselves do not count among the self-interested elites seeking to preserve their own wealth and power. As if the DNC doesn't have big business connections. As if prosecution of white collar crime didn’t already begin slipping during the Obama years before it continued to decline under the Trump administration. As if the border wall as we know it didn’t start with Clinton. As if the people of this country weren't already once again demanding better treatment and less violence and brutality, or renewables weren’t already gaining the upper hand on fossil fuels.

As if there's no third branch of government, the judicial, into which were rammed a couple of conservative Republican nominees, one right after the death of a beloved associate justice. As if there's never any political gridlock within the same party.

Whatever yarn may be spun, we aren’t now looking at some type of Communism-R-Us which will force itself onto the citizenry and bleed it. Plus, Biden is extremely vocal about healing and total bipartisan cooperation, even to a fault.

What we are still facing, though, is a health crisis of horrendous proportions that continues to wreak havoc in a multitude of ways. What’s to appreciate about gridlock when a divided government can't stay funded, pass stimulus, or otherwise genuinely protect and care for its diverse citizenry? What good is gridlock for the sake of gridlock, when what the situation demands instead is compassionate action shaped by flexibility and adaptability? The prototypical American sentiment that everyone shall adjust to the individual who owes no personal responsibility to the rest isn’t working.

But never mind our individual opinions on these topics, the markets and the consensus they reach every trading day have been speaking. The immediate feedback upon the completion of the election cycle was that they seemed to be just fine with a blue wave.

It's also worth remembering that no matter the wave—be it a blue wave, red wave, purple wave, or sine wave—there are always opportunities to generate and preserve wealth. Aside from talk of stimulus, Biden-Harris are telegraphing their intent to incentivize certain sectors. TAN, a major solar panel fund, is up over 200% from one year ago. If such plays continue to pan out, we can thank Biden-Harris for facilitating these additional opportunities for returns, even as they pursue stricter regulations and raise taxes (if/when that ever comes to pass).

Those who instead prefer political gridlock to reduce their tax bill, those who don’t expend the effort and resources to discover investment opportunities and hedge whatever risks they perceive, are those who sound like they want money for nothing. There’s no good reason for an entire country to keep rolling over for that, especially when we have much more pressing concerns that gridlock just can't fix.


Footnotes

¹ “History lessons from past tax hikes.” Fidelity Viewpoints (September 30, 2020).