What’s A Divided Congress Mean For The Stock Market?

To mangle Tolstoy: “All one-party Congresses are alike; each divided Congress is divided in its own way.”

Today the U.S. stock market is in love with yesterday’s election results. Those results removed uncertainty. Eliminated the chance–slight though it was–that the Democrats would control both houses of Congress. And Democratic control of the House will put some restraints, the wishful thinking goes, on President Donald Trump.

Today, Wednesday November 7, the Standard & Poor’s 500 closed up 2.12% and the Dow Jones Industrials fininished ahead 2.13%. The NASDAQ Composite Index gained 2.65%. (It was a great day for technology shares with the Technology Select Sector SPDR ETF (XLK) up 2.94%.) The Russell 2000 small cap ETF (IWM) ended up 1.67%.

Fears of volatility plunged with the CBOE S&P 500 Volatility Index falling 17.83% to 16.36.

Emerging markets finished ahead with the iShares MSCI Emerging Markets ETF gaining 1.88% on the day.

I wouldn’t stand in front of the train driven by these expectations–or at least not quite yet–but I think they could use a little nuance.

Anyone who thinks the election results will restrain President Donald Trump is badly misreading the President. His ability to move legislation will be even lower in the future than it has been and the Democrats will step up oversight of the administration, but as the immediate post-election firing of Attorney General Jeff Sessions demonstrates the President clearly believes that the lesson of the election is “Be even more confrontational.” The bulk of the acton will take place through executive orders and changes in regulation, but that really just increases the reliance on those methods of action in the President’s first two years.

I think it’s extremely like that the White House will push back against efforts of House Democrats to investigate anything–I expect the White House to refuse to answer House subpoenas without court orders. Add in what looks like a Constitutional battle over the Mueller investigation and the President is likely to get the confrontations that he think serve him well politically. (Sessions replacement as Robert Mueller’s boss, Matthew Whitaker, has a long history of criticizing Mueller’s investigation.)

It’s hard to see any legislation moving through a Congress that just got more polarized in Tuesday’s results. Keeping the government open will require Senate and House agreement on a spending bill but after that?

The one potential chance I see for any legislation on infrastructure, changes in immigration law, improvements in Obamacare, and the like will result if Democrats re-elect Nancy Pelosi as the Speaker of the House. Pelosi demonstrated in her initial stint as head of the House back in 2007 that she thinks that the best way to improve Democrats’ chances in the next election is to actually pass some legislation that fulfills the hopes of Democratic voters. I expect that she will try bring some of the same pragmatic thinking to her new stint–assuming her caucus re-elects her. Whether she can take the more fiery progressives in her own party and hard conservative Republicans in the House and Senate to any compromise on anything is a big question for the next two years.

Right now, though, the markets see a divided Congress as a guarantee that the 2017 tax cuts won’t be repealed or revised, that business friendly de-regulation will still be the theme in Washington, and that Democrats might rein in the hardest of hardline positions in the administration on trade.

That optimism feeds right into the usual January Effect and end of the year rally.

Which is one reason I’ve added shares of the iShares Russell 2000 ETF (IWM) to my Jubak Picks portfolio.