Investors are directing their focus to Tuesday’s midterm elections, which will decide control of the U.S. Congress.
If Republicans – who have been taking the lead in polls and betting markets – gain control of either the House of Representatives, the Senate, or both, it will lead to a split government with the presidency under Democrat Joe Biden.
Here are some possible market implications from Tuesday’s vote:
** With a Democrat in the White House, the best market performance has occurred when Republicans controlled either the House, Senate, or both.
Average annual S&P 500 returns have been 14% in a divided Congress and 13% in a Republican-held Congress under a Democratic president, according to data since 1932 analyzed by RBC Capital Markets. That contrasts 10% when Democrats held the presidency and Congress.
The S&P 500 lost 20% in 2022.
** Most strategists are also quick to point to the stock market’s perfect post-midterms track record: The S&P 500 (.SPX) has recorded an increase in each 12-month period after the midterm vote for 19 consecutive occasions since World War Two, according to Deutsche Bank.
Over the previous 18 political cycles, the S&P 500 has surged by an average of over 15% in the year after the midterm vote, according to Oxford Economics.
Investors provide several possible reasons for the post-midterms tailwind, with some saying the vote likely results in a clearer policy outlook. But some are cautious that the streak is at risk this year, given fears that the economy is tipping into a recession.
** While investors likely prefer a political gridlock, one fallout of divided government may be a bruising fight over increasing the U.S. debt ceiling that could deepen concerns over a U.S. default and trigger market volatility.
BTIG said in a recent note:
“We believe the divided government scenario that serves as our base case will lead to fiscal fights similar to those we saw in the 2011-13 period of divided government.”
** Energy, defense, and healthcare are among the areas of the stock market that could witness the most volatility because of the election.
A Republican victory could ease concerns over Democrat initiatives to push through tighter policies on prescription drug prices, and possibly prop up pharmaceutical and biotech stocks. A GOP victory could also raise hopes for increased defense spending and friendlier legislation for the fossil fuel industry.
A surprise Democratic win could boost shares of clean energy and cannabis companies, given expectations the party would more likely favor legislation favorable to those industries.
** Strategists at Morgan Stanley, including Mike Wilson, wrote on Monday that a Democrat victory could strengthen the dollar and push Treasury yields higher, reflecting the view that potentially higher fiscal spending could aggravate inflation and compel the Federal Reserve to hike rates higher than anticipated.