Gearing up for gridlock
Republicans could very well lose at least one chamber of Congress. Here's what that means for investors.
NEW YORK (CNNMoney.com) -- With strong earnings, lower oil prices and a slowing economy to focus on, stock investors haven't exactly been paying attention to next week's congressional elections. But maybe they should be.
According to the latest research from the Cook Political Report and the Wall Street Journal, the Republicans are in danger of losing 20 to 35 seats - and their majority - in the House. In the Senate, the GOP is expected to lose at least four seats, in which case they would still be in control, or as many as six, which would swing the Senate to the Democrats.
Either scenario would mean the president and the Congress will no longer be controlled by the same party, aka gridlock. And for stocks, that's a mixed bag.
In the short term, a change in control of at least one of the chambers of Congress would probably spark a stock selloff, investors and market experts said.
That's because traditionally Republican Wall Street would seem to prefer to have Republicans in control of Capitol Hill as well as the White House since the party's policies are widely viewed as more big business friendly.
Should the Republicans hold on to both chambers of Congress, "we can anticipate an upward - though likely short-lived - trend" in the market, said David Leblang, a political science professor at the University of Colorado, Boulder.
But in the long term, having either party in full control is not necessarily a good thing. In fact, in the long term, "the market actually likes the executive and legislative branches under different leadership as it reduces any damage coming out of Washington," said John Davidson, president of money manager PartnerRe Asset Management.
That was certainly the case in the 1990s when the pairing of Democrat Bill Clinton in the White House and a Republican-controlled Congress coincided with the longest economic expansion in the history of the United States - the famed tech-driven 90's boom.
A recent Ned Davis Research study suggests the market could weaken between the elections and the end of the year, if the last 104 years are any guide.
That's because 2006 is a mid-term year for a second-term president. In such years, a change in one or both houses of Congress has usually coincided with the Dow gaining in the months leading up to the election, and then sputtering or sliding through the end of the year.
That's certainly been the case this year, with the major gauges rallying through a surprisingly strong third quarter and month of October. The Dow hit an all-time closing high of 12,163.66 late last month and is up 12 percent year-to-date. All of which makes the market ripe for some profit taking.
Plus, as the old Wall Street saw suggests, markets hate uncertainty and this election is dripping with it.
"The uncertainty around the election suggests that there will be a sharp reaction once we know which party controls the Congress," said William Bernhard, a political science professor at the University of Illinois, Urbana-Champaign.
Bernhard and Leblang's research suggests that in general, the less predictable the electoral outcome, the more the market might rise or fall once the election has been decided. This is true for both presidential and congressional elections.
But longer term, Bernhard said that the impact on stocks should be muted, due to the fact that the president and Congress will probably end up on opposite sides of the aisle - and since the two major parties themselves are each dealing with internal divisions.
"Gridlock is good," said Ron Kiddoo, chief investment officer at Cozad Asset Management, as it means "negative tax legislation and anything else that's seen as hurting the market won't go through."
In fact, gridlock probably means that no major legislation will be passed in the next few years, as is typical in the second half of a presidential term.
That's because during the third and fourth year of a presidential term, the party in power starts to gear up for the next presidential election, with a focus on staying in power.
These years tend to be good for stocks, according to researchers who think the market tends to follow the four-year cycle of the presidency. (Full story).
In addition, a divided government tends to be "good news for fiscal responsibility" and that should help keep interest rates low, wrote Diane Lim Rogers in a note to CNNMoney.com. Rogers is research director at the Brookings Institution and former chief economist for the House Ways and Means Committee Democrats.
A more fiscally responsible Congress and low interest rates? Sounds promising.
Most of the analysts consulted for this story seemed to agree that the biggest impact will likely be felt by individual sectors, not by the stock market as a whole. For details, see the gallery.