While the major political parties continue debating the midterm election winner, another group is rejoicing in the confusion: Wall St.
Major investors had long projected, and desired, a split House and Senate. Stock markets prefer predictability and there’s plenty of predictability in political gridlock.
The narrative now is that stocks can continue climbing unabated. As J.P. Morgan Chase strategist Marko Kolanovic noted, “we believe (out of consensus) that a split Congress is the best outcome for US and global equity markets.”
The case for stock gains and higher rates
Historically the relationship has been stocks up = rates up, and vice versa.
If the Dow’s 500+ point jump in its first post-election trading day was any indication, stocks and rates are poised to run higher.
Washington gridlock likely means no major political surprises for Wall St to grapple with. Rates will see increased pressure every leg higher in stocks.
If Congress can find a common ground, it would most likely be on a safer topic such as infrastructure. Infrastructure would be a slight positive for stocks, but more spending = more debt = higher rates.
Lastly keep watch for any type of trade agreement with China. Positive developments on trade often lead to big gains in stock markets.
The case for a fall in stocks and lower rates
Catalysts such as an escalation in the trade wars, increased geopolitical tensions, or major shakeups in Washington would all cause stocks to falter. While gridlock is expected, the political climate remains tense and prone to volatility.
Reversals of stimulative policies, such tax cuts and deregulation, will cause stocks to tumble. Just one week after the elections, Rep. Maxine Waters announced easing of banking regulations “will come to an end” in 2019. Stocks dropped instantly on the news.
Lastly, and quite oddly, rising interest rates could actually serve as catalysts for lower rates. Each time rates hit highs recently, stocks waned.
Given stock gains have been spurred by fiscal stimulus and historically low rates, both of which are now being reversed, stock markets are becoming increasingly vulnerable. The level of stimulus deployed after the crisis had never been tried; the same can be said about reversing it.
One curveball: The Fed. If they hike rates too far, it could facilitate big stock market declines. If they stop raising sooner than expected, a variety of outcomes become feasible. Regardless, accurate or not, the Fed will likely be public enemy number one when the next recession occurs.