The Gift of Gridlock

On Christmas Eve, the US Congress is sliding down the chimney with a gift for investors. That gift is...an empty box; nothing; gridlock; inactivity. With the coming of the holidays, calendar year 2013 closed to new legislation with just 58 new laws enacted. And with this meager tally, the 113^th legislative branch just wrapped up the least legislative year in modern history. For investors, this inactivity is a gift to be thankful for.

We certainly heard a lot from the Beltway this year. They argued a lot. They shut down the government in October. Threats of cliffs and cuts, hikes and interest rate spikes ran rampant. Unsurprisingly, a recent Gallup poll showed Congress’ bluster and inactivity was rewarded with the lowest approval rating of all time: 9%. (It has since bounced higher, to a whopping 12%.) This is amazingly unpopular even for Congress, an outfit that hasn’t seen half of poll respondents’ approval since mid-June 2003. With 2014’s midterm elections looming, we’re sure “low favorability with voters” wasn’t high on many politicians’ gift lists. If you work on Capitol Hill, you’re probably doing a lot of damage control with local constituents during your break. But these are politicians’ problems, not investment issues.

Yep, our politicians are a dysfunctional bunch. The good news is America’s competitive economy isn’t in need of governmental help—and hasn’t gotten much of one for the duration of this expansion. Q3 2013’s 4.1% growth aside, headline GDP has been tepid during the past four and a half years—leading many to posit America’s economy is growing too sluggishly. But headline GDP and economic growth are not synonymous, and a quick look at just a few details shows a healthier than widely appreciated private sector. Total government consumption detracted from headline growth in 12 of this expansion’s 17 calendar quarters. In 12 of 17 quarters nonresidential private investment (business investment) rose. Consumer spending grew in all 17 quarters. Imports (sign of healthy demand) advanced in all but one. Ditto for exports. Rising sales and profits at private businesses have them cash rich. And Leading Economic Indicators point to further growth ahead. While some may hope for faster growth, we’d suggest the rate isn’t as important as whether you have growth.A competitive economy should worry more about legislation’s unintended effects than the lack of supposedly growth-enhancing new legislation.

An active government—either packed with one-party representation or bipartisanship—isn’t necessarily good for stocks. Government policy can significantly impact markets, change property rights, create market dislocations like winners and losers or otherwise create uncertainty—potentially roiling markets. For example, 2002’s Sarbanes-Oxley Act, a legislative backlash at Enron and similar accounting scandals, was well intended legislation seeking to, “restore investor confidence.” SarbOx enjoyed support of both Republicans and Democrats alike, passing the House 423-3 and the Senate 99-0. It was signed by President Bush on July 30, only 3 months after its first passing in the House. However, this well-intended piece of legislation greatly increased public firms’ compliance risks and costs—hitting profitability market-wide. The S&P 500 fell sharply while the bill advanced. This is not an isolated example. The Tariff Act of 1930, often known as Smoot-Hawley, was a hugely bipartisan piece of wrongheaded economic policy. And while Smoot-Hawley didn’t create the Great Depression, it did contribute by driving a tariff war that helped crush global trade. Nixon’s early 1970s price controls were bipartisan. Folks, bipartisan support or an active legislature doesn’t ensure sensible policy.

And this is the primary benefit of gridlock in the US: It limits either party’s ability to ram through legislation that could have material economic fallout.

Gridlock doesn’t mean nothing happens, just less extreme things. For example, Congress passed aid for victims of Hurricane Sandy. With typical vitriol, the debt ceiling is now higher. The Fiscal Cliff proved fungible. And the 113^th Congress has seen its share of odd laws passed, like the “Reducing Flight Delays Act of 2013” and HR 2289, which renamed section 219(c) of tax code after former Texas Sen. Kay Bailey Hutchison. You might think the latter a bit frivolous, but we’ll take renaming sections of existing law over price controls and/or tariffs any day of the week.

This is not to say the nation or world is devoid of political risk, it merely means most political risk stems from either regulatory interpretations of older laws or abroad. And neither seem very likely to derail the bull market today. But in our view, it is worth watching how rules under laws like Dodd-Frank—and its litany of mandated studies weighing potential regulatory action—take shape. While the Volcker Rule has finally been finalized, giving some clarity to banks, there is still a fair bit of opacity as banks and regulators seem to differ on some definitions in the rule’s 800-page preamble. The US Commodity Futures Trading Commission is seeking to expand its jurisdiction basically globally—something foreign regulators and firms may not take kindly to. And in the eurozone, progress has been made in creating a banking union, but many questions about it remain—such as how they determine when a bank should be “wound down.”

Ultimately, though, an inactive Congress mitigates the number of moving parts investors must monitor from Washington. That’s a plus, and one we’ll happily tip a glass of eggnog to.