At the time of this writing (Saturday afternoon) pundits are projecting the Republicans will take over the Senate. The latest FiveThirtyEight forecast is that the GDP has a 65% chance of controlling the Senate; some polling organizations have it at much higher odds. Since the Republicans already control the House, a takeover of the Senate would give them control over the legislative branch.

It is believed by many that the election of a Republican controlled House and Senate, which are considered to be more business friendly than Democrats, should provide a bullish boost for the stock market. A recent Barron’s Big Money Poll confirms this view with 57% vs 28% responding that Republican control would be positive for the stock market.

So is this premise fact or fiction? The answer is that it all depends on the time frame. Over the long term that opinion is the metaphorical equivalent of an urban legend. It just ain’t so. Surprisingly, history shows that the stock market and GDP performs better under Democratic presidents. You need look no further than the prolonged bull market under the current administration to see that is true. There are three reasons for this:

  • Republican presidents tend to appoint hawkish Fed officials who prefer tighter monetary policy (higher interest rates) which ends up tanking the market over time. Democrat presidents tend to appoint dovish central bankers who prefer easy monetary policy (low interest rates). With only one exception, all of the Obama appointees to The Federal reserve are considered doves.
  • Republicans tend to pass supply-side legislation, which works with a long lag time. Lowering ordinary income tax rates and capital gains tax rates, and lowering taxes on corporations are examples of time tested ways to improve the economy. But generally these changes in tax policy take a long time before their impact is felt.
  • Republicans tend to control spending better than their Democratic colleagues. But putting a damper on spending in the short run, lowers job creation and GDP output. Fiscal restraint over the long run reduces the federal deficit but it has little positive influence on the economy.

But what happens next Wednesday if we wake up to find out the Republicans will be in control of the Senate beginning in January? What is the possible short term impact for investors?

  • Legislative gridlock between the House and Senate would come to an end. Most pundits believe that if the Republicans are victorious they would move quickly to secure a number of legislative victories on issues like:
    • The Keystone pipeline
    • Repealing the medical device tax
    • Fast-tracking liquefied natural gas export licenses for the sale of natural gas to Europe

The Republicans will want to prove that they can govern if given the opportunity. The obvious beneficiaries would be companies in the energy and medical sectors.

  • Republicans would be able to set the legislative agenda but getting any major legislation passed that could improve the economy would still require 60 votes in the Senate which is highly unlikely in these partisan times.
  • But a new type of gridlock between Congress and the White House would likely ensue. Congress could pass legislation but the President still has the ability to veto. No one knows how this would play out. The big concern is the potential battle on federal spending between Congress and the President. The confrontation between the two branches of government could end up with fiscal brinkmanship that would make past fights over the debt limit look like child’s play. And while this is happening, the stock market would likely go on a rollercoaster ride with every turn of events.

So does a Republican win Tuesday help the stock market? No one knows. We will have to wait and see.

Sources: Will Republicans Rattle the Market in November?, by Anthony Mirhaydari, The Fiscal Times, September 8, 2014; The bullish and bearish implications of the midterm elections, humblestudentofthemarkets.blogspot.com, October 21, 2104; Midterm Elections: Would a Republican Win Be Bullish for the Stock Market?, by Jared Dillian, The 10th Man, Mauldin Economics, October 30, 2014.

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