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Midterm Elections: Market Implications

Election commentary by Jeff Kleintop, chief market strategist at LPL Financial

NEW YORK (TheStreet) -- The GOP is likely to take the majority in the House and hold about half of the Senate. The likely return to political balance between the parties in Washington may slow the pace of legislative change and result in the "gridlock" the market has historically favored.

The President's party has traditionally lost seats in Congress during the midterm elections making it harder to pass new legislation in the second half of the Presidential term. This pattern is magnified this year in terms of impact. Based on polling data, the 2010 midterm elections are likely to mark a return to a balance across the aisles in Washington as the political pendulum swings back from the sweeping majority in the House and Senate the Democrats picked up in 2006 and consolidated in 2008. This balance lowers the probability of dramatic legislative changes and is likely to result in the return of "gridlock."

Historically, the stock market has performed better under periods of "gridlock," but this record is far from consistent. Not surprisingly, other factors appear to bear more weight than politics. On the other hand, the bond market clearly has performed much better during periods of gridlock, most likely because investors assign a lower probability to the passage of new spending initiatives that would increase the debt supply.

With the start of the fourth quarter, the stock market entered what has historically been the best four-quarter period of performance during the four-year presidential cycle. Since World War II, the stock market has always posted a double-digit gain from the end of the third quarter of year two to the end of the third quarter of year three of the Presidential cycle, and that gain has consistently averaged an impressive 30%.

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