The recent mid-term elections gave Republicans control of both the House and the Senate. Many economists and investment strategists are cheering the Republican takeover since they believe it will mean positive changes ahead for the U.S. economy. If history teaches us any lesson, however, they are likely to be disappointed.
The last time Republicans swept mid-term elections in similar fashion was in 1994. At that time American voters were fed up with a rising tide of liberal policies under a two-term Democratic president and were eager for a change. Conservative Republicans campaigning under the promise to roll back taxes and onerous regulatory burdens were pushed into Congress by an angry electorate. The promises that many candidates of this “Conservative Revolution” made to their voters were, however, quickly broken and a business-as-usual attitude was embraced by the incoming congressmen. They were unwilling to give a Democrat president the credit for any positive legislative changes that might have been created, so they did nothing of note.
Fast forward to today and the parallels are uncanny: a two-term Democrat president who is viewed by some as ineffectual and a voting public disenchanted with higher taxes and a gridlocked Congress have once again led a conservative revolution on Capitol Hill. Promises abound among the many incoming freshmen congressmen, but the outcome is likely to be much the same as in 1994. There simply isn’t enough unanimity among Republicans on key issues to lead to meaningful changes, and the incentive isn’t there to do anything the President might get credit for. Therefore a do-nothing approach is the most likely outcome.
Investors have no reason to fear this, however, as a do-nothing Congress has been just what the doctor ordered for the corporate outlook and stock market. With Republicans and Democrats unwilling to compromise, the financial market recovery has persisted these last six years with nary a serious setback along the way. That’s because when Congress is on the same page and making “progress” it usually results in a higher tax and regulatory burden for businesses and taxpayers. In other words, we the people get the screws.
I’m convinced the reason why the recovery has continued on for as long as it has – in defiance of the long-term cyclical norm – is partly because Washington politicians have been unable to derail it through a unified legislative agenda. The constant partisan bickering amongst themselves and with the president has led to a lack of agreement on areas which affect all of us, including taxes, energy policy and small business regulations. Thankfully, the potential damage to the economy has been minimized due to Congress’ failure to reach agreement in these areas.
The Congressional cycle, which happens to be bullish for stocks, is also a factor for equities going forward. Economist Ed Yardeni mentioned this cyclical indicator in a recent blog posting. His statistical consultant, Jim Marsten, wrote the following:
“Suppose I told you there is a technical indicator that, once the buy signal was given, has an amazing record--with the S&P 500 up three months later 17 times out of 18 since 1942, up six months later 18 times out of 18, and up 12 months later 18 times out of 18. The only condition this technical indicator has to meet is a particular political-calendar date, i.e., mid-term election day, which happens to be tomorrow. Buying on that day is one of the best technical strategies I have ever seen. One has to go back to Depression-era market losses to find two periods when this indicator did not give consistently positive results. The historical odds are almost 100% in your favor. The average percentage changes are also good since 1942: 8.5% for the three-month periods, 15.0% for six months, and 15.6% for 12 months.”
It’s no coincidence that one reason why this indicator works is because election years normally coincide with bottoms in the Kress yearly cycle series. Next year is also the fifth year of the decade, which historically is one of the most bullish years in the decadal rhythm for equity prices. The Year Five Indicator hasn’t had a single miss going back over 100 years. With all the major yearly cycles up next year, and with the Congressional cycle in its peak phase, the odds greatly favor a bullish 2015 for stocks.
Since a gridlocked Congress is the closest we can come to the Jeffersonian ideal of “That government is best which governs least,” it should be viewed as a blessing in disguise. As investors and taxpayers, we can only hope it continues for at least two more years.