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Why Gridlock May Actually Be Bad for Economy, Stocks

Friday, 29 Oct 2010 | 1:56 PM ET

Fictional financial predator Gordon Gekko famously proclaimed in Oliver Stone's "Wall Street" that "Greed...is good." Twenty-three years later, many on the real Wall Street are proclaiming that "Gridlock is good."

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But is it? Will the logjam expected to develop in Washington after Tuesday's elections actually result in a rally on the notion that split control between Democrats and Republicans will block politicians from doing anything else to hurt the economy?

While the notion is a popular one, history suggests otherwise.

With a slew of vital issues looming such as unemployment, taxes and health care just to name a few, a do-nothing Congress could be just what the economy doesn't need now.

"The biggest thing they're going to jump at right off the bat is extending tax cuts and which ones to extend. If there's gridlock and they can't reach any kind of a deal, then all the tax cuts go," says Ken Goldstein, economist at the Conference Board. "If you think gridlock is good, be careful what you wish for."

To be sure, the market could rally immediately after the election if investors think the end of Democratic rule will help propel the economy forward.

But the effect would be short-lived if Congress fails to address issues near to the hearts both of Wall Street and average Americans.

"The perception initially will be that gridlock is going to be good because it will take some uncertainty off the table. It will be less likely that we see sweeping legislation coming through Congress," says David Twibell, president of wealth management at Colorado Capital Bank in Denver. "Looking a little bit longer term, we need to have the government playing a positive role in some of these issues. If what we get is just a lot of arguments I question whether that's really a good thing."

Standard & Poor's has evaluated the data of what actually does happen to stocks during a divided government, and the answers might be surprising. The study examined three conditions: Total unity, when one party controls the White House, Senate and House of Representatives; partial gridlock, where one party controls both houses of Congress and another the White House; and total gridlock, when Congress is split.

Of the three scenarios, the best comes not when government is divided but actually during total unity, under which the S&P 500 has seen a 10.7 percent post-World War II return. The worst? When there is total gridlock, when the benchmark has gained just 3.5 percent.

Looking at the numbers more internally, there is a tie for best performance when looking at party control. Both complete Republican control, and a Democratic president and Republican Congress have had returns of 15.1 percent. The latter scenario was best seen under the Clinton administration and often serves as the template for the "gridlock-is-good" crowd.

After pursuing a leftist agenda for his first two years in office, during which Democrats controlled both chambers, Clinton saw the economy languish while the stock market did little. But Republicans took over after the 1994 elections, and while the two sides bickered for the next six years the dot-com bubble hit and stocks ultimately exploded 208 percent during the Clinton years.

"I believe investors look to Washington for leadership, not obstacles," Sam Stovall, S&P's chief equity strategist, wrote in a note accompanying the data. "Should a split Congress be the result of the November 2 elections, the resulting uncertainty may just end up adding one more stone to this already high wall of worry..."

At the onset, at least, leaders from both parties are likely at least to talk up unity, even if any honeymoon is short lived.

Can GOP Revive Economy?
Discussing whether the Republicans can revive the economy if they take over Congress, with Karen Finney, Democratic Strategist, former DNC Communications director, and JD Hayworth, former Congressman (R-AZ), and CNBC's John Harwood.

But both investors and voters may grow impatient with Congress if it doesn't make quick decisions on whether to continue the Bush tax cuts that expire at the end of the year, as well as whether the ObamaCare health reform plan stays intact.

"The good thing with perceived gridlock is at least bad things for business won't be coming out of Washington anymore," says Steve East, chief economist and market strategist at Height Analytics in Washington, D.C. "To take a longer-term view, gridlock is not good. The country has big problems. It would be better for the intermediate and long-term health of the economy and markets if we could deal with it before it becomes an outright crisis."

For consumers, things still feel like they're in a crisis mode, so they're unlikely to be patient with Wall Street inaction as well. A survey from the Conference Board this weekon consumer confidence showed a slight increase over the previous month but continuing pessimism about the economy.

"Essentially consumers are saying we don't care what the egghead economists are saying, this still feels like a recession," Goldstein says. "It doesn't make any difference whether Washington raises our income tax by five bucks or if the City Hall raises the dog licenses by five bucks. We've only got one pocket."

So whether gridlock will be good likely will depend on whether those pockets are feeling any fuller after the new regime takes hold.

"There will be a tremendous amount of uncertainty if we don't have policy action," Twibell says. "So I don't know if gridlock gets rid of the uncertainty. I think it just shifts it around when all is said and done."

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