Gridlock at Last?

Daily State of the Markets 
Wednesday Morning – January 20, 2010  

Good morning. Stocks rallied unexpectedly on Tuesday in response to the possibility that Republican Scott Brown could win the special Senate election in Massachusetts. In a classic case of stocks discounting the outcome of an event, the indices reversed Friday’s dance to the downside and moved to modest new highs for the cycle on the hope that some form of gridlock would return to the beltway.

Logic would seem to dictate that the stock market would perform well under a Republican-dominated administration and Congress (assumed to be a pro-business environment) and that stocks might suffer when the Democrats were in control. But in reality, nothing could be farther than the truth.

According to a study done by Ned Davis Research, the stock market has actually performed best when there is gridlock in Washington, meaning that one party controls the White House while the other controls Congress. The thinking is that stocks prefer an environment where neither party can push legislation through without a fight.

Looking at the statistics, history shows that since 1901, the Dow Jones Industrial Average has gained 1.62% per year on average when the country had a Republican President and a Republican-controlled Congress. Surprisingly, the market has done better (average gain of +6.56% per year) when the Democrats have been running the show. But the best scenario for stock investors appears to be when we have a Democratic President and a Republican-controlled Congress. Stocks then gain ground at an impressive 9.63% per year.

While this study does make it clear that the stock market is basically an “independent” voter, it does not really explain why stocks would rally on the back of a single Senate race. Objectively speaking, the Pelosi/Reid Congress is viewed as pro-tax and anti-business while the President has made no bones about his distaste for the “fat cat bankers” of this country. So, the fact the Democrats will no longer have the “super majority” in the Senate which allows them to push through anything and everything they can come up with is viewed as a positive by traders.

Stocks also rallied yesterday in the face of another tightening move in China and some additional concerns about Greece. So, while you may not agree with the politics of the market and you may be concerned about earnings and the many issues around globe, there is no denying the fact that our heroes in horns have put on an impressive display of resiliency lately.

Turning to this morning, we’ve got a full plate with earnings from some big banks (which were disappointing), more tightening moves in China (lending to stop for remainder of January), and a couple of economic reports to report.

For starters, the Labor Department reported the Producer Price Index for December increased by +0.2%, which was above the consensus estimate for an unchanged reading. When you strip out food and energy, the so-called Core PPI came in flat, which was a tenth better than the consensus for +0.1%. On a year-over-year basis, the PPI has increased by +4.4% while the Core is up +0.9%.

Next up, Housing Starts in December fell 4% to an annualized rate of 557K, which was below the consensus for 572K. The November numbers were revised slightly higher to 580K from 574K.

Finally, Building Permits for December came in with a gain of 10.9% at 653K vs. 580K. The November was revised higher to 589K from 584K.

Running through the rest of the pre-game indicators, the overseas markets are mostly lower in response to word that the Chinese have ordered banks to stop lending for the remainder of the month. Crude futures are down $1.35 to $77.67. On the interest rate front, we’ve got the yield on the 10-yr trading higher at 3.65%. Next, gold is moving down by $13.70 and the dollar is higher against the Yen, the Euro, and the Pound possibly in response to the election results. Finally, with about 45 minutes before the bell, stock futures in the U.S. are pointing to a lower open. The Dow futures are currently off by about 50 points; the S&P’s are down about 6 points, while the NASDAQ looks to be about 11 points below fair value at the moment.

* Report includes items that make comparisons to the consensus estimate questionable

Wall Street Research Summary

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