So much for the midterms.
Now the markets can start obsessing about gridlock, impeachment and the 2020 election.
And they can resume worrying about bread-and-butter issues like corporate earnings, interest rates and the threat of rising tariffs and recession.
Uncertainty about control of Congress has at last been lifted: Come January, the Democrats will run the House, while the Republicans will retain a slender majority in the Senate.
From the standpoint of the markets, that welcome clarity on Wednesday set off the biggest one-day midterm election rally since 1982. And while investors were relieved that the results conformed with Wall Street expectations, longstanding financial concerns were made even more visible while introducing a series of other political problems.
“The midterm results only highlight the ongoing political divisions within the country and the parties,” John Raines, head of political risk at the business information service IHS Markit, and Lindsay Newman, a principal analyst there, wrote on Wednesday.
Sooner rather than later, the focus of financial markets is likely to shift to new sets of political and economic concerns.
On the political side, these include:
■ The likelihood of investigations of the Trump administration in the House of Representatives and perhaps, down the road, impeachment proceedings.
■ The prospect of congressional gridlock and vituperation.
■ Rising partisan conflict as politicians prepare for 2020.
At the same time, the markets will refocus on the bread-and-butter concerns that have weighed on stock and bond returns for much of the year.
Among these worries are the possibilities that:
■ The rate of corporate earnings growth, unusually robust right now, has already peaked, creating a benchmark that most companies won’t meet next year.
■ The Federal Reserve’s interest rate increases will slow the economy, puncturing the prices of risky assets like stocks, which have already begun to lose altitude.
■ The Trump administration’s aggressive trade policy — and worsening foreign relations with allies and adversaries alike — will raise global tensions further and hurt the economy.
■ After a long recovery, the economy will fall into a recession in the next two years, pushing stocks into a deep bear market.
This may seem like an excessively glum list, right after elections that sent the stock market into a bout of euphoria. If the markets abhor uncertainty, then these midterm elections were wonderfully reassuring.
“The consensus was right,” John Lynch, chief investment strategist for LPL Financial, wrote on Wednesday. Wall Street generally viewed the election’s broad outcome as highly probable and fairly desirable, though not the outcome thought most likely to produce the highest future stock returns.
That would have been a Republican sweep with a large majority in the Senate as well as the House, leading to a repeal of the Affordable Care Act and cuts in programs like Social Security and Medicare.
The UBS Global Wealth Management Chief Investment Office gamed out the various possibilities ahead of the election, concluding that such a sweep “should boost global stock markets, limit increases in long-term bond yields, and support the U.S. dollar.”
But the “base case” that UBS and most other analysts forecast ahead of the voting was what actually happened — a split decision producing gridlock. The real-world validation of so much consensus opinion tilted stock prices upward. And as I wrote last week, the markets have generally prospered after the midterms, regardless of which party has won.
In addition, despite substantial evidence to the contrary, there is a deep, stock-bolstering belief on Wall Street that gridlock — defined as a political alignment in which no single party controls all three branches of government — has been good for the market.
But the data bears this out only when a Democrat has been president and Republicans have held either the House or the Senate. Since 1901, in all such cases, the Dow Jones industrial average has outperformed its long-term average, an analysis by Bespoke Investment Group shows. When a Republican has been president during a stretch of gridlock, the market has lagged.
In the five previous congressional sessions since 1901 in which Republicans controlled the White House and the Senate while Democrats controlled the House — the political alignment in Washington starting in January — the annualized return has been a loss of 1.69 percent. That’s not encouraging, though the data is too scanty to use “as a blueprint for what to expect this time around,” Bespoke said.
The IHS Markit analysis predicted a “legislative impasse” in the new Congress but reserved the possibility of deals on big issues. And several analysts said these might be an infrastructure rebuilding program, measures to reduce prescription drug prices or an agreement to help the so-called Dreamers. These are the young undocumented immigrants who have benefited from an Obama-era program called Deferred Action for Childhood Arrivals, or DACA, but face the possibility of deportation under current Trump administration policies.
But President Trump could demand that a deal on the Dreamers be paired with funding for his coveted border wall, an objective that many Democrats abhor.
The one sure thing in Washington appears to be a high level of political strife. That was underlined on Wednesday when Mr. Trump fired Attorney General Jeff Sessions and replaced him with Matthew G. Whitaker, a loyalist who has been critical of the special counsel investigation into Russia’s election interference. House investigations into these matters could begin early next year, and, at some point, the start of impeachment proceedings is certainly possible.
History suggests that while such developments would rattle the markets, they needn’t hurt stock prices much. Bill Clinton is the only president to have been impeached in the last century — he was eventually acquitted by the Senate — and the stock market prospered during much of his ordeal.
Market performance during the Watergate scandal is less reassuring. President Richard Nixon resigned from office in August 1974, after the impeachment process began. (In his resignation speech, he conceded that could not avoid impeachment by the House and conviction by the Senate.)
The stock market fell sharply during the truncated Nixon impeachment process, but that is likely because of the recession that began in November 1973. That downturn continued until March 1975, impairing the political prospects of President Gerald Ford, Nixon’s successor.
That is a reminder that while the stock market can withstand political stress, it is one of the many victims of recessions, which throw people out of work, destroy wealth and alter political destinies. A recession would be the market’s biggest worry. It might become Mr. Trump’s, as well.
