Is A Split Congress Good For The Market? ETFs In Focus

The U.S. mid-term election held on Nov 6 expectedly delivered a split Congress with Democrats taking control of the House and Republicans maintaining their hold over the Senate. And history says a “gridlock is good.”

And why not? Wednesday saw a larger-than-average post-midterms rally, which marks “the biggest post-midterms gain for both the Dow and S&P 500 since the day after the 1982 contests.” The S&P 500 and Dow Jones Industrial Average both gained more than 2% on Nov 7.

Historical Trend

Per an IBD research report, S&P 500 returns during each two-year election cycle, from election day to election day, produced the best average of 18.7% when Congress was divided. “Unified control of Congress by the same party as the president yielded an average 17.3% two-year gain. When control of Congress was unified under the opposition party, gains averaged 15.7%,” per IBD.

A chart from Bank of America Merrill Lynch (NYSE:BAC) (BAML) shows that since 1928, stocks have delivered an annual average return of 12% in years with a Republican president in office and Congress was divided. And in the year subsequent to a mid-term election that delivers a Republican president and a split Congress, returns have been more than 20% on average.

During the course of Trump’s presidency – which started with both houses under Republicans’ control – markets rejoiced fiscal reflation like tax cuts but seesawed on trade war tensions. “Thus gridlock (nothing done, nothing undone) might not be a bad outcome, and has historically been a good environment for stocks,” per BAML analysts.

Rising Yields Will Likely be in Check

With expectations of a split Congress keeping Trump from pushing tax cuts further and keeping growing budget deficit under control, bond markets might see a check in rising rates. In absence of rising rate worries, stocks should trend higher.

Will Gridlock Keep the Fed from Being Outright Hawkish?

“There may be a view Democrats will rein in fiscal spending,” said Michael Arone, chief investment strategist at State Street (NYSE:STT) Global Advisors, as quoted on MarketWatch. He also added that since fiscal reflation under the Trump presidency boosted U.S. economic growth, giving the Fed a leeway of hiking key rates faster, a political holdup may result in slower economic growth and a less hawkish Fed.

Investors should note that “ith tax cuts and the previous spending increase in the rearview mirror, the pace of growth is due to slow down”, believes Bill Diviney, senior economist at ABN Amro.

ETFs in Focus

Against this backdrop, we highlight below a few ETFs that have gained considerably following the results of mid-term elections.

Clean Energy

It is one of the Democrats-friendly bets.First Trust Global Wind Energy ETF (NYSE:XLE) ( (LON:FAN) ) and Invesco Solar ETF ( (LON:TAN) ) added about 3.3% and 3.2% on Nov 7, respectively.

Healthcare

Since the repeal of the Affordable Care Act (ACA) looks difficult now, iShares US Healthcare Providers ETF (IHF) and SPDR S&P Health Care Services (NYSE:XHS) ETF (XHS) jumped 3.8% and 2% on Nov 7, respectively (read: Must-Watch ETF Areas Before Mid-Term Elections).

Emerging Markets

If a rise in treasury yields remains in check and a moderately growing U.S. economy keeps the greenback subdued, emerging market ETFs may rebound. iShares Edge MSCI Multifactor Emerging Markets ETF (EMGF) gained about 2.3% on Nov 7.

Technology

The space has been hit hard of late on overvaluation concerns and rising rate worries. Now a divided government may give the space some room to breathe and help it play out nicely on its own fundamentals. First Trust Dow Jones Internet ETF FDN rose 3.1% on Nov 7 (read: Why to Buy the Dip in FAANG ETFs).

Momentum

The fund tracks the Dow Jones U.S. Thematic Market Neutral Momentum Index. If there is a stock market rally, iShares Edge MSCI USA Momentum Factor ETF MTUM should gain. The fund was up about 3% on Nov 7 (read: A New ETF on Breakout Stocks Enters Market).

Materials

Some investors may expect some moderation in China trade tensions, which is going to help material stocks. Also, both parties are in favor of boosting infrastructure spending. All these can set material stocks in a rally. Materials Select Sector SPDR ETF (XLB) advanced 1.8% on Nov 7.

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