To gridlock or not to gridlock: That is the question.
For weeks now, markets have come to believe Republicans will lose their majority in the House of Representatives. One result has been a brisk rally in stocks.
"Historically, the market has tended to perform fairly well when government wasn't so dominated by one single party," says Ken Tower, chief market strategist at CyberTrader.com. "In a gridlock situation, the other party provides a brake on whatever party is more dominant."
But as things grow more and more ominous for the GOP, investors are having second thoughts. What if Democrats also took over the Senate, which seems possible, and against a weakened president could unlock the grid on their own?
"If the Senate goes as well, or even if it's close enough, concern seeps into the marketplace," says Leslie Alperstein, president of Washington Analysis, a political-economics research firm. He notes that drug stocks, a political football in the 1990s, have become a drag on the Dow Jones Industrial Average ($INDU).
These are legitimate worries, but I think they're the kind that forms the proverbial wall of worry that any bull market has to climb. The fact is, the Federal Reserve appears to be guiding the economy into that prayed-for soft landing.
One bellwether is bonds. They prosper in tough times, and were rallying this summer, but have stopped. Another is stocks. Growth rewards them, and they are perky.
Gridlock schmidlock: This market's ready to party.
Odds and (Republican) endsStocks began to advance sharply in August, with the Dow Jones Industrial Average spurting past its previous high, set in early 2000. By Oct. 4, the most widely followed benchmark, the S&P 500 ($INX), had sprinted ahead nearly 7% in seven weeks.
This coincided with a clear trend toward Democrats seizing control of the House. At Intrade.com, an electronic bourse headquartered in Ireland where futures contracts on U.S. political races are traded, "our contract shows that there is a 41% probability that Republicans will retain (control of) the House of Representatives," says John Delaney, chief executive.
That's a reversal of this summer's consensus, which was that terrorism and memories of 9/11 would bolster the GOP. But then came a hat trick of political upheavals: an internal government report showing Iraq has become a breeding ground for terrorists; Bob Woodward's exposé of a dysfunctional Bush administration; and the Foley Follies, in which a GOP congressman, who has since resigned, played seduction games with high school students.
So dire have things become for Republicans that the Senate looks increasingly vulnerable. Intrade's contract on the GOP retaining control plunged to a probability of 63.6% on Oct. 11, from 87.2% when it was issued just seven days earlier.
In those same seven days the Dow's upward momentum disappeared. Despite a continuing rally in industrial-materials stocks, which make up 30% of the index, the Dow was flat. One culprit: its health-care constituents, notably, which declined nearly 4%.
Alperstein says the market views health care as particularly vulnerable to political differences, with Democrats regarded as less friendly than their opponents toward the sector.
Democrats are also increasingly hostile to free trade, a crucial underpinning of global expansion. In Ohio, incumbent GOP Sen. Michael DeWine is in jeopardy of losing his seat to Democrat Rep. Sherrod Brown, whose main campaign theme is that free trade has "sold out our country."
'Politics is irrelevant'Are these facts the canary in the market's coal mine, warning of threats to come? Or do they amount to Chicken Little, squawking at imaginary disaster?
The market, after all, doesn't dislike Democrats; it did just fine under Bill Clinton. What it dislikes is unanticipated change. So it's possible, and even likely, that the current political situation is irrelevant to everybody but day traders.
"Let other people worry about the month-to-month. Go up to 10,000 feet, and you'll see that things are humming along very nicely," says Dan Wiener, editor of the Independent Adviser for Vanguard Investors newsletter.
Wiener scoffs at the notion Democrats pose any threat to health care, or indeed to anything else. The control they might win would be tissue paper-thin, and moderates could easily sidetrack controversial initiatives.
"Politics is irrelevant," Wiener says. "Interest rates are low. Corporate earnings are growing by double digits. The explosion that everyone was worried about in housing hasn't occurred."
Indeed, he points out that mortgage refinancings are surging again, due mainly to homeowners replacing adjustable rate notes with those of fixed maturity. That allows them to sidestep the kind of much-larger rate increases that could produce an avalanche of foreclosures.
Historically, the two months after a midterm election have been very favorable to stocks, and so has the third year of a presidential term, which 2007 will be. The market's current rally began in exactly this season four years ago.
You take gridlock. I'll take Goldilocks. This market is just right.
At the time of publication, Tim Middleton didn't own any securities mentioned in this article.