Stock market loves a divided government

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By John Grace

Contributing Columnist

America has been waiting to exhale for the past four years. Now that we can breathe again, we can look forward.

A discussion with my very smart friend, Glenn Dorsey, senior vice president and client portfolio manager at Clark Capital Management Group, helps put things in perspective.

The last time we had a situation like this was after the 2000 election between George W. Bush and Al Gore. We all learned what a hanging chad was and that counting is much more complicated than we thought.

We also learned that the old expression, “The market can handle good news and bad news, but not uncertainty,” has a basis in truth.

The S&P 500 declined nearly 5% from Nov. 7, 2000 (the day before the election) until Dec. 12 (the day before Bush was officially declared the winner). It would not be surprising to see heightened levels of volatility as politicians and lawyers battle over deadlines, procedures and outcomes this time around.

Investors will once again focus on the things that truly matter — the fundamentals. We believe the economic rebound we have been experiencing should continue, no matter which candidate ultimately wins.

Republicans and Democrats should finally be able to pass an additional economic stimulus package. The long-awaited infrastructure package, which may be the only thing both parties actually agree on, will likely get passed.

With fiscal policy, Senate control is at least as important as the White House. Under a narrow Republican Senate majority, we would expect no major tax increases, but also a fiscal stimulus package of less than $1 trillion.

With a Democratic Senate, we would expect Congress to enact a fiscal stimulus package of at least double that size regardless of the White House outcome, though the size could grow a bit larger if Biden wins the White House (to $2.5 to $3 trillion).

Tax increases that go to fund additional spending increases would likely also occur under a Democratic sweep, but not under a Democratic Senate and a Trump White House.

Interest rates are likely to stay low, but there may be some upward pressure if Biden wins and some of the more expensive measures (universal health care for example) are implemented. An increase in tax rates, both corporate and personal, will influence rates as well.

Higher corporate taxes should act as a governor on rates and higher personal tax rates will likely increase the appeal of municipal bonds.

Before the election, stocks rose on “Blue Wave” hopes, but divided government suits it just fine, too. Investors seem to be pricing in a Joe Biden presidency and a split Congress, where Republicans continue to control the Senate and Democrats the House. At the end of the day, the “stock market’s post-election rally may be a sign that gridlock in Washington is good for Wall Street,” as Mark Hulbert described at MarketWatch, Nov. 5.

After the election noise fades behind us, we believe the market will return to focusing on fundamentals, such as corporate earnings, interest rates and the economy. We know that over time, stock prices track earnings and that earnings are highly correlated to the economy.

S&P 500 earnings are rebounding strongly since the COVID-inspired drop earlier this year. Analysts’ estimates indicate that earnings could well eclipse their prior levels in the second half of 2021.

The spending wave peaked in 2007 for the U.S. and in 2011 in Europe. We have been living off of quantitative easing ever since, to make up for the slowdown that happened once the baby boomers began to age and spend less.

This generation was the largest in modern history in the developed world and dominated the global economy until recent decades. People today spend the most money on average at age 47, and targeting that age is the best way to project booms and busts for decades to come.

It was age 46 for the baby boomers and could be as old as age 50 for the Zillennials (Generation Z) in the decades ahead.

The generational spending cycle peaked in 2007. Now, the technology cycle is peaking very close to 90 years after the infamous 1929 bubble peak — and that creates the most powerful 90-year cycle for stocks. “That peak provides a very strong indicator that we are about to see the greatest stock crash since 1929–1932,” wrote Harry Dent of Dent Research to subscribers Nov. 4. “The leading Nasdaq 100 bubble either peaked on Sept. 2 or will soon after the election if we finally get that strong stimulus package we were promised from the government before the election.”

Over the last 41 years we have learned that savvy investors seem to hate losses more than they love gains. Now is the time to design and implement your exit strategies before the grits hit the pan. Again.

Under a narrow Republican Senate majority, we would expect no major tax increases, but also a fiscal stimulus package of less than $1 trillion.

John L. Grace is president of Investor’s Advantage Corp, a Los Angeles-area financial planning firm that has been helping investors manage wealth and prepare for a more prosperous future since 1979. His On the Money column runs monthly in The Wave.