Wall Street Bet On A 'Blue Wave,' But Divided Government Suits It Just Fine Too

Caption

A woman walks by the New York Stock Exchange on Oct. 5. Stock markets are rallying at the prospect that this week's elections will result in a divided government. / AFP via Getty Images

Updated at 4:23 p.m. ET

Wall Street seemed to love the prospect of a "blue wave" just a few days ago. Now that Democrats appear less likely to get the landslide they hoped for, investors are happy about that as well.

Stock prices began climbing early in the week, when polls showed that Democrats could capture both the Senate and the White House, giving them complete control of Washington.

The Dow Jones Industrial Average finished 1.6% higher on Monday and then rose more than 2% before polls closed on Election Day.

Though Wall Street is usually wary of Democratic control of government, investors saw it as the best chance to pass the kind of economic relief bill that markets have been clamoring for during the coronavirus pandemic.

The election outcome still remains uncertain. But former Vice President Joe Biden is leading President Trump, while hopes for a Democratic-led Senate have faded.

A Biden win and a Republican-led upper chamber would mean a divided government for at least the next two years.

Yet stocks continued to climb. The Dow finished up by another 542 points Thursday, an increase of nearly 2%. The S&P 500 also ended up nearly 2%.

"I am calling it the 'Tails I win, Heads I Win' market," tweeted David Rosenberg, chief economist at Rosenberg Research.

Reading the market tea leaves at a volatile time can be challenging. But it's axiomatic on Wall Street that periods of divided government often herald a boom for stocks.

"If you look back over previous eras, when you have had a Democratic president and a split Congress, markets have risen around 13%. There's no reason to think this will be any different," said Scott Glasser, co-chief investment officer at ClearBridge Investments.

Senate Majority Leader Mitch McConnell, R-Ky., said on Wednesday that he wants to see some kind of relief bill before the end of the year after previously saying such a package would have to wait until early 2021.

Any bill will likely be considerably smaller than it would have been under Democratic control, which worries Gregory Daco, chief U.S. economist at Oxford Economics.

"The economy is sending distressing signals to policymakers, but it's uncertain whether significant fiscal support will arrive before year-end, particularly with post-election policy gridlock likely in Washington, D.C.," Daco said.

Economists have urged Congress to pass a new relief bill as coronavirus cases again spike across the United States.

But investors are taking comfort in the prospect that a Republican-led Senate would put the brakes on many Democratic initiatives that Wall Street looks askance at, such as an increase in corporate taxes, which is a key part of Biden's agenda.

"You've almost certainly now taken that off the table because of the Senate vote and lack of a blue wave," Glasser says.

Prospects of a diluted Democratic economic agenda because of split control of Congress, along with a new relief bill this year, would be a welcome development in markets, according to Seema Shah, chief strategist at Principal Global Investors.

"Lower chances of tax hikes, regulatory action and a fiscal stimulus bill create a positive backdrop for the market," said Shah.

She also points out that much of the surge in stock prices over the past decade has been driven by the Federal Reserve and other central banks making money cheaper, something that's likely to continue whatever the makeup of Congress.

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