As expected, Wednesday the Fed announced it would restart quantitative easing by buying $600 billion in US Treasuries.
2010's US midterm elections are in the books, increasing gridlock and decreasing political risk—a positive result for markets.
Political risk usually wanes after midterms and in the third year of the presidential cycle—both show historically good returns for stocks.
Going into it, we knew this would be an eventful week—midterm elections, a host of economic reports, and a much anticipated Fed announcement.
As expected, Wednesday the Fed confirmed it would restart quantitative easing by buying $600 billion in US Treasuries. We don't think additional easing is necessary—the system is plenty liquid already—but neither should it be too detrimental in the near term. The longer-term inflationary impact hinges on future Fed actions.
The conclusion of 2010's midterm elections, at (very) long last, was just as notable as the Fed's action. The results were likewise as expected and good news for stocks. The Democrats lost power—as the president's party usually does in midterms.
MarketMinder doesn't root for either party over the other. We keep our fingers crossed for political balance, often termed gridlock. That may sound ominous, but gridlock isn't when nothing gets done—a functioning government is an important underpinning to the free market. But new legislation has the power to change the business landscape materially and is very difficult to handicap. When neither party has the ability to pass laws unilaterally—like the Democrats in recent years—negotiation filters out or files down controversial measures and decreases political risk.
Positively, following two overactive legislative years, that's precisely what looks to be in store for the next two. Eleven races are undecided in the House and three in the Senate. But it's certain voters dealt the Dems a diminished majority in the Senate and awarded the House to the Republicans. Republicans netted at least 60 seats and now control a solid House majority of 239. The Democrats maintain a slim majority in the Senate but lost the ability to block a minority filibuster without significant concession.
The outcome recalls 1994 when former-President Bill Clinton's failed healthcare reform push led the Republicans to regain a House majority. The second half of the 1990s was marked by political controversy but less legislative risk. House Republican gains in 2010 have already eclipsed 1994's 52-seat gain. If every contentious House seat turned red (unlikely), the Republicans would tie the all-time record gain of 71 in 1938. As it stands, the Republicans' 60-seat gain is the biggest since 1948.
Whatever the ultimate result, the moderating influence of midterms has historically marked great forward returns for stocks here in the US. Since 1926, no 12-month period after a midterm election has been negative (outside the 1930s) and returns have averaged +19%.* On the heels of midterms, the third year of the presidential cycle is similarly sweet for stocks, averaging +17.5% without a negative return since 1939.**
Of course, the future is perfectly capable of dealing an unexpected aberration, but we don't think that's likely. Positive fundamentals continue to gather strength but are little appreciated. This dour mood is at least partly due to the fact a political pall has shadowed markets for two years. Now, investors can breathe a sigh of relief as the caustic cloud dissipates in the US and the rest of the world too.
* House of Representatives, Global Financial Data, Inc., S&P 500 total return
** Global Financial Data, Inc., S&P 500 total return from 12/31/1925 to 12/31/2009