The market will now test the theory that a split Congress yields a rally in stocks.
Democrats won the House of Representatives in Tuesday's elections and the Republicans maintained control of the Senate. When Congress is split and the president is Republican, stocks tend to do exceedingly well.
Stocks usually see a 15.7% gain in the year after midterm elections that produce a split Congress under a Republican president, according to data from LPL Financial. Not only do stocks usually see that longer runway of growth after this result, but that runway tends to start with a quick bounce. The S&P 500 sees an average gain of 10.7% from its October low through the end of the year, LPL Financial noted. Last month was an incredibly ugly one for stocks. The low was on Oct. 29 when the S&P 500 traded just above 2,640. The index already has risen 4.3% from that low, so if history is an indicator of the future the gains for the rest of the year have just begun.
As for this year, specifically, earnings growth is expected to slow down -- albeit slow down from a considerable peak. The third-quarter earnings season, which is almost over, has seen an estimated 26% earnings growth. Earnings are estimated to grow at 20% for the fourth quarter, and just under 10% for the first quarter of 2019. That slowdown is part of what investors feared in October, and that's what they got.
John Lynch, chief investment strategist for LPL Financial, said he thinks valuations are still low and stocks are still ripe for picking. While the S&P 500 average trailing 12 months price-to-earnings ratio is still slightly above 20, the forward PE ratio is relatively low.
"The latest pullback in the S&P 500, which has been accompanied by rising earnings, leaves the S&P 500 at just over 15 times the next 12 months earnings estimates," Lynch wrote in a recent note. He added, "That level is slightly below the long-term average of 15.7% (since 1950), but quite a bit below the post-1980 average of nearly 17%. With interest rates still quite reasonable, if not historically low (about 3.1% on the 10-year Treasury), and inflation well contained, we would argue valuations are attractive even if earnings over the next year fall a bit short of estimates."