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Why the midterm election could be good for stocks

If it's November, It must be the mid-term elections. This week, voters will take to the polls to elect some new members of both the House and the Senate. What will that mean for stocks in the short and longer term? If history is any guide, a good house cleaning is good for stocks.

Traders on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters
Traders on the floor of the New York Stock Exchange.

On Tuesday, there are four potential outcomes. We could have a Democratic president that is supported by a completely Democratic Congress (not possible), a Democratic Senate/Republican House (current makeup and possible), A Republican Senate and Democratic House (not possible) or finally a fully Republican Congress (most likely) and what the data show is that the combination of a Democratic president (Obama) married to a Republican Congress will produce the best long-term results at least over the next six months.

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Of either of the two most possible outcomes, the consensus is for continued gridlock and frustration — and that is not necessarily bad for stocks.

Many believe that these mid-term elections are inconsequential as Obama is in his second term — essentially a lame duck — so no matter what happens, could it really get any worse? Probably not. But many are hoping that it will shed light on how the 2016 elections are shaping up.

Remember, Congress has been almost irrelevant during the whole Obama presidency due to their lack of or inability to compromise and work together for the common good of the nation. The gridlock has been of epic proportions — debt-ceiling debates that threatened the very faith and credit of the U.S. took center stage and the forced government shutdown only exacerbated the fissure. Tax increases, defense cuts, and the great financial crisis rendered the whole group incapable of moving the nation forward. As a result, the country has not seen any significant fiscal policy reform, tax reform, or structural reforms meant to help the economy grow organically. What we have seen is the Federal Reserve take control and launch five massive monetary policy initiatives as it tried to right the economy and do the job that elected officials could not.

So from an investment perspective, the focus has been on the Fed and not the government — the question to ask is, will anything change effective Wednesday morning? Will there be light at the end of the tunnel?

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Well, probably not right away as some races are too close to call. The recounts and the runoff votes will continue to stir the debate. Markets prefer as much clarity as they can get and stocks react well when there is a definitive change in management — conversely — they stumble (become volatile) when the outlook remains cloudy – I suspect that we will see a bit of that in the weeks ahead.

If history is a guide, a Republican win of both houses coupled with a Democratic president should see stocks rally — 16 percent on average over the next six months. This doesn't mean, though, that there won't be any volatility — sectors to watch include financials, big banks, defense contractors, medical device makers and energy. If we remain split, then infrastructure stocks, hospitals, healthcare and alternative energy may be some of the favorites.

The frustration and resulting volatility for the markets will be if there are too many races that end in a deadlock — causing "do-overs" and ballot recounts. In fact, some speculate that we may not really know what the makeup of the Congress is until after the New Year resulting in a stunted Christmas rally.

Stay tuned — as the day unfolds, I think Americans are sick and tired of the status quo and will now demand change. If so, the market should reward us.

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Commentary by Kenny Polcari, director of NYSE floor operations at O'Neil Securities. He is also a CNBC contributor, often appearing on "Power Lunch." Follow Kenny on Twitter @kennypolcari and visit him at kennypolcari.com.

Disclosure: The market commentary is the opinion of the author and is based on decades of industry and market experience; however no guarantee is made or implied with respect to these opinions. This commentary is not nor is it intended to be relied upon as authoritative or taken in substitution for the exercise of judgment. The comments noted herein should not be construed as an offer to sell or the solicitation of an offer to buy or sell any financial product, or an official statement or endorsement of O'Neil Securities or its affiliates.