Ask a Trust Officer
Dear Trust Officer:
I’ve heard that investors prefer divided government. What does the Republican takeover of the Senate mean for the stock market?
Anecdotally, there is a widespread belief that the gridlock of divided government reduces legislative interference in the markets and lets businesses tend to business, which, in turn, is good for stocks. Recent history reinforces the perception, as the stock market has gained over 11% annually since the Republicans took over the House in January 2010.
However, a longer-term statistical review pokes holes in the theory. A study commissioned by The New York Times found that from 1901 to the present, divided governments produced annual returns of just 4.06% in the DJIA compared to 6.27% for the entire period. The years of one-party control of the Presidency and both houses of Congress provided 7.88% returns.
The fundamental performance of the economy and attitudes of investors are likely more important indicators of stock market performance than shifts in the political winds.
In 2009, as the economy was just coming out of recession, stocks were undervalued, with a long-term price/earnings ratio for the S&P 500 at 14.12, according to the data of economist Robert Shiller.
After several years of steady growth, investors have become more confident, and thus have bid stock prices up to the point that the P/E ratio is at 26.51, where it was in 2006. That suggests that future stock market gains will have to be powered more by profit growth, and less by investor optimism.
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