Post-Election Market Trajectory: Rocky at First, Then Steady

Short-term pain, long-term stasis. That’s the outlook from market strategists in response to what is shaping up to be a potentially split Congress where majorities are thin.

The pain part, meaning market turbulence, was apparent Wednesday, as stocks slid amid the midterm election’s mixed verdict and the prospect that today’s inflation report would not be good news (the Consumer Price Index actually came in at a cooler-than-expected 7.7% yearly on Thursday morning). Following three days of gains, the S&P 500 shed 2.1%, but then rebounded mightily Thursday on the CPI announcement.

As Tobin Marcus, senior U.S. policy and politics strategist at investment bank advisory firm Evercore, explained in a client note, “a pro-Democratic surprise might drive a short-term selloff, even if Dems do not actually retain their House majority.” With control of the Senate unclear, Marcus predicted “some choppy market movements in the days and weeks ahead.”

Still, things should settle down, according to Sam Stovall, chief investment strategist at CFRA. Since World War II, during periods with a Democrat as president and both houses under GOP control, calendar years averaged a 13.0% market advance. When Democrats controlled the White House and the two congressional chambers were split, the market rose a small amount more, 13.6%. Market gains occurred 60% and 70% of the time, respectively.

Of course, that would be quite a trick in 2023, given the current financial climate. The benchmark index is down 21.3% this year.

History also shows that split control usually leads to relative inaction on Capitol Hill, and equities seem to enjoy such a status quo. “That tight of a split in both houses of Congress will constrain any policy action and will almost certainly prevent any veto overrides on laws that do get through,” wrote Brad McMillan, CIO for Commonwealth Financial Network, in a note.

What that means, he went on, is “current fiscal policies will remain in place: no tax cuts and no major spending bills for the next two years.”

Unfortunately, a gridlocked Congress may turn out to be a problem if a recession occurs and the national debt ceiling must rise. To George Smith, portfolio strategist for LPL Financial, “a recession may be incrementally deeper, if we have one, due to a likely smaller fiscal response in a split government.”

Further, failure to raise the debt ceiling could also have a harmful economic impact, Smith indicated in a note, warning . that “markets have usually reacted negatively when it starts to look possible that the U.S. may default on its debt.”