Americans just made President Obama a lame duck with an opposition Congress. No one can do anything big. Stalemate - that's great! Politicians who can't do anything can't mess anything up.
Few fathom this. Most UK media coverage portrayed last week's midterm election results as negative. Some articles bemoaned both parties' inability to pass anything now. Others said the Republicans' Senate sweep weakens Obama - bad for the world. Sociologically, most of the world wants a decisive, strong American leader.
Stocks don't care about sociology, though. Or ideology - stocks are blind to party creed. Stocks care whether politicians meddle with free markets. In capitalist, competitive countries like America, stocks are happiest when government can't do a darned thing.
Midterm elections make markets happy. Not once since 1946 have the 12 months after midterms been negative. The first three quarters - the midterm-year Q4 and the following Q1 and Q2 - are a sweet spot I call The 86.4% Miracle. Why? In the S&P 500's 88-year history, each is positive 86.4% of the time. Far higher than the 67.8% frequency of positive returns in all calendar quarters. Miraculous!
The identical frequency is a quirky coincidence that might never happen again. Something different could happen and throw the numbers off. The astounding consistency, however, is no coincidence. Midterms increase gridlock! In all but two midterm elections since 1930, the President lost power at midterms. The outliers occurred in Franklin Roosevelt’s and George W. Bush's first terms.
Gridlock at its greatest
Obama is a second-termer and official lame duck - gridlock at its greatest. Stocks love lame ducks, too! Since 1946, the S&P 500 rose in 85.7% of lame-duck Presidential years (years three and four of the second term). Far above the 72.7% frequency of up years overall.
Lame-duck years are often up big. The S&P rose 24.6% in 1951 and 18.5% in 1952, Harry Truman’s lame-duck years. Dwight Eisenhower's were more mixed - 11.9% in 1959 and 0.5% in 1960 - but Lyndon Johnson's were strong. 23.9% in 1967 and 11% in 1968. Gerald Ford's were astounding, 37.3% in 1975 and 23.7% in 1976. Reagan had the 1987 drop, but stocks rebounded fast, finished the year positive, and rose 16.6% in 1988. Bill Clinton's first lame-duck year, 1999, finished up 21%. 2000 fell -9.1% as the dot-com bubble burst - not a political factor. Similar for George W. Bush. Stocks rose 5.5% in 2007 but fell -37% in 2008. But gridlock didn't cause the financial panic. Nor would non-gridlock have shortened it.
Markets breathe easy
Stocks love gridlock and hate active lawmakers. The more laws Congress passes, the likelier they are to redraw property rights, rewrite regulation or redistribute wealth, resources and capital. All create winners and losers, dragging down stocks. Prospect Theory tells us if a new law shifts resources from Group A to Group B, Group A hates it over twice as much as Group B loves it. The more folks fear Congress will take from them, the more their negativity weighs on stocks. Even the threat of radical legislation makes markets risk averse. If Congress can't pass anything, stocks know nothing changes. Markets breathe easy.
Gridlock is reliably positive, but few see it - hence its power. People hate gridlock! Polarisation! Annoying bickering! Voters think, "I elected those bums so they could fix things, not just argue! I want my money back!" The fewer laws Congress passes, the lower approval ratings sink. 2013's Congress passed a record-low 72 measures. Their approval hit a then-record-low 9%. They're on track to pass fewer this year, and approval sank to 7%.
Republican and Democratic stalwarts hate when their party's proposals can't pass. They see their party's plans as best and the opposition's as worst. Independent folks want bipartisan compromise - supposedly Goldilocks policy. Most don't realise some of America's worst laws are bipartisan. 2002's Sarbanes-Oxley Act passed the Senate 99-1. Pure bipartisan! But also extreme. It made life hell for corporate accountants and CEOs and reeled the ongoing bear market into another tailspin.
America doesn't need fixing!
Few believe doing nothing is best. Americans today don't believe it. A Democratic President with a Republican Congress makes no one happy! Republicans hate that their new majority can't pass anything. Democrats hate that Obama can't push his agenda. Independents hate how polarised both parties are today and wish they could all hold hands, get along, and fix America.
America doesn't need fixing! Like Britain, America has free markets and strong property rights - a mighty economic backbone. Is there room for improvement? Of course - no country is perfect! But the chance Congress could "improve" anything without collateral damage is tiny. Even the best-intended changes have unintended consequences. No change means no consequences - the absence of this negative is a huge positive almost no one sees.
America's government will have a harder time screwing things up for two years. Stocks know it and love it even if people don't.
This is an American phenomenon, but own foreign stocks, too - false fears are global! Here are two foreign stocks I like.
Own foreign stocks
Folks broadly fear Europe backsliding into recession. The Conference Board Leading Economic Index series makes this irrational. Meanwhile, Volkswagen is off 19% year to date, mostly since June. Buying opportunity! It rolls with great brands, new models, moderate growth and devotion to research and development. It's also cheap at 50% of book value, 20% of sales and eight times my 2015 earnings estimate with a 2% dividend yield.
Buy directly into Chinese false fears via giant Industrial & Commercial Bank of China. It has gone nowhere slowly. But it is about time. Fundamental progress is relatively steady. It's now dirt cheap at five times my 2015 earnings estimate, one times book value - with a 5.6% dividend yield.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.