Friday, October 13, 2006

Divided Government

MSN Money has an article today called "An investment Guide to the MidTerm Elections" which addresses my comment from a recent post that investors were probably hoping for a Democratic takeover of Congress because they perceive divided government as good for the market:

Forget politics. Before you cast your ballot in November, think how it will affect your portfolio.

Some on Wall Street expect the stock market to benefit if the Democrats gain enough seats to take control of the House of Representatives. The linchpin of this idea is that political gridlock is good for stocks. A Congress divided between a Democrat-controlled House and a Republican-run Senate and White House reduces the chance that lawmakers will upset the legal and regulatory status quo.

I don't really agree with the analysis, but I do believe that a lot of people think this way. The idea seems to be that gridlock reduces the chances of legislation passing and therefore spending may be brought under some kind of control:

But if bonds make up a big part of your portfolio, you may want to support Democrats this year, the study suggests. It shows that during periods of divided government, bonds generally beat stocks. Johnson and his colleagues conclude that gridlock does lead to a slowdown in legislation and to slower growth in spending. That should mean smaller budget deficits, which means the government needs to issue less debt. That could lead to lower interest rates, and since bond prices move inversely with yields, bond holders tend to benefit.

My fear is that divided government at this time in history will just result in the same spending from Republicans on defense and increased spending on domestic programs from Democrats. Discretionary spending growth under Republican control has already been growing at rates faster than inflation. Luckily, it has grown slower than the rate of increase in tax revenues and that coupled with above trend GDP growth has reduced the deficit as a percentage of GDP. However, with the Baby Boomers starting to retire, the current deficit pales in comparison with the long run budget problems created by Social Security and Medicare. Divided government will certainly make it less likely that Congress will address those issues.

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