Elections and Markets: I'm Not Dead Yet
We look back across elections for context on mixed power structures, relative dysfunction, and what it meant for markets.
For those of us who have watched too many elections that were a matter of life and death or signaled a dramatic secular change for the ages (or until the next Congressional election, whichever comes first), they all seem very important in the heat of battle. The rooting section gets tied to whatever ideological biases one might hold, but those in the markets then get back to business. In reality, however, the easy way to view the ebb and flow of politics is to remind ourselves of a few things:
The 1980s: The bull market 1980s was a case study in a divided Washington with the GOP in the White House and the House owned by the Democrats. The House controls the purse strings in the US Constitution, so that means a lot.
The 1990s: The bull market 1990s was for the most part divided during the critical post-1994 stretch when the market really ran wild. The Republican Revolution of 1994 overlapped with the two terms of Bill Clinton.
The housing boom years of the 2000s: In the aftermath of the TMT crisis into the new millennium, the most important people in Washington were the one making the decisions on monetary policy as the Fed waded into 2004 at 1% Fed funds before the excess of those years took off to new heights.
Post-crisis, post-2008: Whether under Obama or Trump, the markets were still driven by the Fed in a world of ZIRP and QE. The appointments of the Fed were more important than the Senate-House mix in healing the wounds of the credit crisis. The Fed accommodation lasted years even with modest tightening of late 2015-2018.
The attempts at tax hikes (Obama first two years) and legislated tax cuts (Trump at the end of 2017) still take a back seat to the Fed in how the market has behaved. The COVID era of 2020 and the intensive support of the Fed saw more coordination between the Fed, the UST, and Congress.
Do markets like political gridlock?
In this note, I offer one person’s view on the inevitable question of “Do markets like a split power base and dysfunctional Washington since gridlocks prevent sweeping changes?” The idea is that the inability to maneuver legislation easily translates into the inability to do serious damage. The good news is that the bull markets of the 1980s and 1990s make a very good case that a split power base is better for markets. The predictability of the variables is greater, and the confidence in the range of outcomes higher. Those were great years for the markets even with some unhappy endings when the excesses drove setbacks that trumped growth. The Fed is also more crucial now, but in bad way (hiking rates) more reminiscent of Volcker than in the ZIRP years of Obama and Trump.
The market valuation successes certainly see periods when some parts of the economy go “too far, too fast” (excessive lending, too much commercial real estate, housing crashes, tech speculation, etc.). The Fed has often been the dominant factor in driving the market, more than the fiscal decision makers. One can argue that the 1990s market boom needed the financial services deregulation, and that was a bipartisan process. Credit expansion brings growth. The forward political analysis is whether the two parties have changed so much since the 1990s that they cannot work productively in such sweeping areas as market reform and economic growth planning. That is the “bygone era” theme (Archie Bunker on piano).
The challenge comes when external events force a legislative response…
The role of the Fed in turbocharging the cycles offers a reminder that Congress is often a spectator, and the political party power mix is not the main event. There are also times when the outside world intervenes with threats such as war (or terrorism) and pestilence (COVID). Those can be catalysts that get politicians fighting over the right response. These are the times when the alignment of the White House and Congress can be a critical factor. If bad decisions get made, the conditions are ripe for one party to take control of the White House and Congress. That is when the extremes of policy remind everyone why unified control is a bad idea.
Political agnosticism is supposed to be the rule in stock and bond research…
As an analyst, one is supposed to be politically agnostic in framing the moving parts. You look at the facts, apply the concepts, make assumptions, and handicap the effects of shifting power balances on policy actions. We are supposed to gauge legislative initiatives, regulatory change, or economic incentives. You need to objectively handicap matters like defense budgets (a big issue if one rolls Ukraine aid into the numbers), tax stimulus, or wealth redistribution ambitions. For example, material climate legislation may die with a divided power structure. Whether Ukraine aid also goes by the wayside will play out. Those are topics for other days since they tie into industry and company fundamentals. Trade policy will be a huge variable ahead for various reasons with China being reason #1.
Sometimes it is hard to be objective when you find some of the candidates (including in your own party of choice) to be any combination of ignorant, dishonest, hypocritical, or bereft of any economic conceptual foundation in their views. Some seem to be simply worthless tools – and these days angrier and more violent tools than past elections. Many believe those types can found in both parties – both Democrats and Republicans. Many agree with half of that. Therein lies the problem.
A few election examples and Washington backdrops as food for thought…
A quick look at how often power has been split in Washington tells a story. The short version is that most of the bull market 1980s and 1990s were divided with 12 years of the GOP in the White House (two terms Reagan, one Bush) and 8 years of Democrats (Clinton). Democrats controlled the House (and thus the purse strings) for the entire 1980s. The Senate was the main battlefield, and that is important given the filibuster and appointment power.
The election of 1980 sets the stage: The election of 1980 marked the start of the Reagan era, which many old-school GOP folks view as political nirvana in domestic and foreign affairs. Sustained deregulation (some started under Carter), lower taxes (very much a Reagan priority), industrial stimulus (investment credits, tax incentives, etc.), and an aggressive defense buildup and heightened Cold Warrior strategy led the list. Defense was a big boost for a range of tech-centric industry subsectors and patent generators. Some of the stimulus had to be scaled back later in the face of budget deficit problems, but the growth tailwinds were strong. Meanwhile, Volcker was retrenching on inflation fighting with the victory at hand.
When we look back at the 1980s and the explosive growth in GDP (nominal GDP doubled in the decade), it is worth remembering there was a GOP President from Jan 1981 through the end of the decade. At the same time, there was a Democratic House every year for the entire decade. The GOP regained the Senate with the 1980 election but lost that edge in 1986 election. The economy and markets stayed bullish. I look at those cyclical histories in other commentaries. An interesting twist on the 1980 election (Reagan took office January 1981) was that his job started in the middle of a brutal bout of stagflation and soaring interest rates with the Volcker policies. Volcker had taken the helm under Carter (Aug 1979 start date).
Bottom line: The US saw a double-dip recession across 1980-1982 as a divided government was in place. Then the cycles turned. Since the 1980s was a bull market and the White House occupied by the GOP for almost the entire decade, it is safe to say that the market liked it. Or was that not the main event? Inflation had been beaten down by the Fed, oil was plunging and bottomed in 1986, demographics were positive, and banking/finance brought lot of credit to the corporate sector and at the household level. Most of this was going to happen regardless of who was in office.
The 1990s and the next bull market decade got off to a rough start: The recession of 1990 saw beaten down markets into 1990-1991. The period also came with a divided Washington with George HW Bush facing a Democratic Senate and House. Then came Clinton, who took the White House with 43% of the vote in the 1992 election against Bush and Perot. Clinton had two years of a united Washington to make waves. Then 1994 changed the political lineup dramatically.
I have looked in other commentaries at the grim backdrop from 1989 to 1992 in banking/finance and various industry groups. The Fed worked overtime with very low rates to get the economy back in order. In weak economic times like 1990-1991, such a divided government (GOP in White House, Dems in Congress) was not the overriding driver of economic trends or in the markets. The Fed was the major force. Clinton started in the job in January 1993 with a Democratic Senate and Democratic House. As we saw with Obama in 2008, that united government party control was short-lived, and the 1994 Republican Revolution arrived with a vengeance.
The 1990s bull market includes GOP control of the Senate and House from Jan 1995 through the end of the decade. The 1980s under Reagan and the 1990s under Clinton saw mostly divided control in a two-decade span that saw almost 18% annual returns in equities and explosive growth in the capital markets, expansion of the economy, and rapid evolution of the technology sector. All of that came with less regulation rather than more and with bipartisan support to open up more markets to competition. There were plenty of problems with the process as we cover elsewhere (notably in underwriting), but that was impressive growth in a diversifying economy.
On the narrow topic of whether markets like divided government, most of the petri dishes we have are just that – markets with divided political power. When the control of the variables moves outside the control of Washington (oil prices, 9/11, bad lending, and reckless underwriting practices, etc.) that is when decision-making can get tricky. When the party in control gets to wander too far outside a broadly embraced and balanced agenda (Clinton first two years, Obama first two years, Trump first two years), then the reaction is usually swift and significant. We did not see a red wave this week, but we await a final tally. We could never test the theory on Reagan since it took the House a long time to get over Nixon and Watergate. The Democrats held control of the House until 1994.
The GOP gained full control of the Senate and House combined in 1994, but Clinton was in their way. In 2000, Bush won the election with both the Senate and House in GOP control. The brief 2001 recession soon saw 9/11 and the start of two decades of war. That reminded all of us of what we could not control. At that time, I lived across the street from Ground Zero and was trying to build a new research company with some colleagues. That was a tough process from a hotel room for a few months. Some things you just cannot plan for.
The Middle East war changed budget priorities and the fate of GOP control. The GOP were in charge in the 2002 midterms on a wave of patriotism before the challenges of invading Iraq became the main event. The cycle was more controlled by the hyper-easing of Greenspan across 2001-2002 all the way to the 1% fed funds of early 2004. Fed support was more important than Congressional mix.
Bottom line: Washington is typically divided in party power. Whether during bull markets or recessions, the more predictable Washington is, the more markets like it. In a recession, they generally will vote you out (Carter, GHW Bush). So if you are going to have one as President, make it in your second term! The more Washington gets roiled by external events, the more the decision-making process can get out of control when the parties don’t agree (war, tariffs, taxes, wealth redistribution, etc.). The unpredictability factor in theory should apply to the White House. That helped Biden in 2020 with Trump too unpredictable for many.
As we see into the late 1990s, life and cycles go on across elections whether the guy in the White House is a A-teamer or just more electable. Those two bull market decades of the 1980s-1990s had more mixed power structures than united party control with the GOP and Democrats seeing split governments most of the time.
After 12 years of 2% handle average growth under Obama and Trump before a post-COVID 5% handle in Year 1 of Biden, we don’t have a great sample in that time frame of where to be optimistic on growth. The Fed, ZIRP, and QE has dominated the backdrop. Both Obama and Trump had only two years of solo party control. Those came after a massive financial crisis (Obama) and with a pandemic (Trump), so to reach a conclusion in that mess, you simply need to make it up.
For this current election, the policy risks and imbalances can be more logically framed once we find out who controls the Senate. That might take a few more days.
About the picture at the top of this piece…
Monty Python’s Holy Grail might be too British for many, but it takes joy in attacking the sanctimonious side of politics. The Arthurian legends are not the way I remember them in grade school. The extreme views of some radical lefties in the agrarian autonomous collective scene were likely used at Arthur’s next rally at his castle. The movie was released in 1975, the year of a US recession trough that ran from the Nov 1973 business cycle peak during the Arab oil Embargo through the March 1975 lows. CPI started 1975 at 11.8% and ended the year at 7.1% while unemployment peaked at 9% in May.
On the topic of whether the markets like a gridlocked Washington, this stretch of years is not a great example with Watergate hearings and a possible impeachment in the works. Nixon resigned in Aug 1974 and Gerald Ford took the reins from his seat as Vice President. As a reminder, Ford was only in that seat when Spiro Agnew (Nixon’s election running mate) had to resign on a range of corruption investigations from his pre-White House years. Agnew was big on attacking the media as “nattering nabobs of negativism.” So attacking the media has plenty of precedent. That was a very divided year, and the entire 1970s was a market nightmare from the end of Vietnam through the end of the decade. Negative real returns on stocks and bonds about sums it up.