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Political Gridlock Is Supposed to Be Good for Stocks. The Data Don't Support That.

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Political gridlock is generally thought to be good for the stock market, with neither Democrats nor Republicans receiving a broad mandate from voters that would lead to extreme policy changes.

It was certainly good for stocks last week. The S&P 500 rose 7.3%, its best weekly gain since April, ahead of Democrat Joe Biden taking the White House and Democrats and Republicans potentially splitting control of Congress.

In the long run, though, there is little evidence gridlock has an effect on stock returns. Since the 1928 election, there has been virtually no difference in the annual return of the S&P 500 in years when one party controlled Washington versus periods when power was split.

In fact, the index has slightly outperformed when control of the presidency and Congress has been unified under one party.

In the 45 years that the same party controlled Congress and the White House, the average return on the S&P 500 was 7.45%, according to Dow Jones Market Data. In the 46 years that power was split, the average return was 7.26%.

What is most important to keep in mind is that every cycle is different, said BTIG analyst Julian Emanuel. Right now if Mr. Biden can bring a less divisive version of gridlock, that would be a welcome change from the past few years of extreme volatility, he said. Although the S&P 500 is up 64% since the 2016 election, investors have endured periods of turbulence, including two bear markets, that were real “gut checks,” he said.

“All else being equal, lower volatility should be a net positive,” he added.

Investors are betting a Republican Senate could limit Mr. Biden’s tax and stimulus plans. That will have ripple effects on capital gains, interest rates and even monetary policy. The fate of Senate control will hinge on two runoff elections in Georgia in January.

Tech stocks climbed last week on bets that antitrust furor will die down. Health-care stocks rallied on lower chances of big changes to government health plans. Regional banks, however, dropped on the lowered probability of a big stimulus package, as did Treasury yields and municipal bonds.

“If the government remains divided, as appears likely, markets historically are said to take some comfort in the prospect of policy gridlock, under the assumption that nothing too damaging to the economy is likely to occur,” said David Joy, chief market strategist at Ameriprise.

Going back to 1929, the most common power structure in Washington has seen Democrats controlling the White House and both chambers of Congress. The S&P 500 rose an above-average 9.4% annually in those 34 years.

The next-most-common was a gridlock in which Republicans controlled the White House and Democrats oversaw both houses of Congress. The market’s annual return in those 22 years was a below-average 4.9%.

The best gridlock return was an average 13.6% under a Democratic president and Senate and Republican House of Representatives. However, that structure was in place for only four years, 2011 through 2014, during Barack Obama’s presidency, when the economy was still recovering from the financial crisis and the market was bolstered by aggressive Federal Reserve policies.

Not including 2020, there have been six years when Republicans controlled the White House and Senate while Democrats led the House. The average return in those years was 9.8%. As of Friday, the S&P 500 was up 8.6% in 2020.

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Interestingly, there has been no time frame when Democrats controlled the White House and House of Representatives and Republicans held the Senate. Yet that appears to be a likely scenario for 2021.

One issue with trying to analyze gridlock and the markets, investors say, is that there are myriad ways to analyze the data. Outlier years like 2009, when the market rallied off the lows of the financial crisis, can skew the entire average, said Tom McLoughlin, head of Americas fixed income at UBS Global Wealth Management. Deciding when to start the analysis has an even bigger impact, he added.

“The bottom line is that the sample size isn’t large enough to draw a firm conclusion,” Mr. McLoughlin said. “As a colleague said to me, ‘Come back in 500 years and we’ll talk.’”

Write to Paul Vigna at paul.vigna@wsj.com