What a Divided or United Government Means for Investors

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. It's the morning after midterm elections in the U.S., and at this time, it's unclear who will control the U.S. House and Senate.

Here to discuss what a divided or a united government means for investors is Dave Sekera. Dave is Morningstar's chief U.S. market strategist.

Dave, a couple weeks before the midterm elections, you wrote a column that noted that while the election outcome will certainly have ramifications for the next congressional agenda, it might not be something that long-term investors should get too worked up about. Talk about that.

Dave Sekera: When I think about the market, and think about it from a long-term perspective, there certainly could be some changes for individual sectors, depending on what the agenda is and what the spending priorities are in any new spending programs. But the impact on those individual sectors, while they may be large for that individual sector, when I think about it from a broad market standpoint, isn't going to affect necessarily the broad market valuation.

For long-term investors, what I'm really more concerned about is where is the market valuation today? And based on that valuation, what is that baking in in the future as far as future expectations for the economy, the inflation outlook, and so forth? And so the midterms, again, I don't think that they're necessarily going to change, or at least not to a large degree, our outlook for the economy and for inflation. And when I look at the market today based on our valuations, we think the market is probably about 15% to 20% undervalued. So, either way, however the midterms turn out, I'm pretty comfortable for long-term investors putting new money to work today.

Dziubinski: Let's look at the two different scenarios, Dave. If Republicans do gain control of either the House or the Senate we're looking at a divided government. What does that mean for government spending and for legislation?

Sekera: Again, that's really going to bring us back to a gridlock situation. And in that case, we just expect really a status quo of the current spending programs that are out there today. And so I really wouldn't be looking for any new large spending programs other than maybe defense. That would be certainly one area where I could see both parties coming together and seeing some additional spending there. But for the most part, I think we'd just be looking at the next two years as a continuation of the ongoing programs today.

Dziubinski: What then might a divided government mean for Morningstar's outlook on the market?

Sekera: Again, it gets back to thinking about what is the market baking in today. And under that divided government without having any new major changes in legislation or spending programs, our base-case scenario is still that the market is pretty undervalued today by about 15% to 20%.

Dziubinski: Then let's pivot over to the opposite scenario, which is where the Democrats retain control of Congress. What might that mean for government spending and legislation?

Sekera: You have to remember a lot of what the initial Democratic priorities were. A lot of that has already gotten passed over the past two years. So, thinking about things like the Inflation Reduction Act and the amount of additional spending that we've seen there in order to really accelerate the United States' transition to clean and renewable energy has already occurred.

I think a lot of the impact for the stock market and those specific sectors has probably already occurred. When we're thinking about what new additional spending programs then might be over the next two years under a united government, I think a lot of that spending would actually go more for social programs as opposed to programs that would impact corporate earnings. And so that's why we don't necessarily think that a united government really will change our outlook as far as the economy and for inflation and thus stocks.

Dziubinski: Might there be changes then to Morningstar's outlook for the markets if the Democratic Party retains control?

Sekera: For the overall market, I don't think so. And again, it's always barring what ends up getting passed through could be significantly different and more meaningful than maybe what we're contemplating, which of course we would then have to bake into our expectations going forward. But for now, I'm thinking that most of those changes and those spending priorities really would be limited more to individual sectors, and we could see impacts in those sectors, but it's not something that we think changes that overall economic and inflation outlook.

Dziubinski: Then Dave, once the results are final, do you think we might see a little bit less volatility in the stock market or does that depend on the results?

Sekera: I think irrespective of the results, we still expect to see a lot more volatility in the markets going forward. And that gets back to those headwinds we identified at the beginning of the year that we thought the markets were going to have to contend with this year.

Again, coming into the year, we thought the markets were overvalued. We noted that there were really four different things that they were going to have to contend with. One, the expectation that the economy was going to slow down, which we'd certainly seen; the Fed tightening monetary policy, which they've actually even been more hawkish, I think, than what we necessarily expected at the beginning of the year; inflation running hot this year--we still have yet to see inflation really meaningfully turn a corner and start coming back down; and our expectation that interest rates were going to increase.

All four of those headwinds are still playing out and will play out probably at least for the next several months, if not the next quarter or two. So, as those headwinds still continue to buffet the market back and forth, I do expect that we're going to see much volatility coming forward.

Now having said that, we do think that the markets are undervalued enough that if you're a long-term investor, and you've got the intestinal fortitude to be able to weather these headwinds, I do think that when we come out of this later next year, you're going to be pretty happy that you were able to stick through that because, again, we do think markets, generally speaking, are very undervalued.

Dziubinski: Well, Dave, thank you for your long-term perspective amid now political uncertainty, let alone market uncertainty. We appreciate your time.

Sekera: All right. Thank you, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.