- Stock market activity in the run-up to the November 6 midterm elections has defied historical patterns.
- What happens after could also be unexpected.
- The results could have major implications for policies like tax reform, which have fueled investor gains this year.
- We’ve compiled an investing guide for the midterm elections using recommendations from some of Wall Street’s top strategists.
It all comes down to the wire next week.
After a bitter campaign, Americans will decide who constitutes the 116th Congress during the final two years of President Donald Trump’s first term.
Republicans have touted their economic achievements and the promise of immigration reform in their attempt to maintain or expand their majorities in the House and Senate. Meanwhile, Democrats have flagged shortcomings of this administration, and of Trump himself, with the goal of regaining control of at least the House.
Only four times in the last 150 years has an incumbent president’s party gained ground in the midterm elections. For months, various polls have indicated the norm should prevail, with Democrats recapturing the House.
But for investors, the run-up to these elections has been anything but typical.
Stocks have historically fallen from April to September during midterm years before rebounding in the fourth quarter. They’ve done the opposite in 2018, with volatility staying low in the third quarter even though the US-China trade war flared up. It wasn’t until September that stocks began to roll over.
Investors may have become less sensitive to policy uncertainty, said David Kostin, the chief US equity strategist at Goldman Sachs.
„Accordingly, to the extent that the typical 8% S&P 500 rally during 4Q of midterm election years — twice the median return of 4% in other years — is driven by declining uncertainty, that pattern may be less likely to repeat this year,“ he wrote in a recent client note.
That said, the S&P 500 averages a 10.6% gain in midterm years from October through December, according to LPL Financial. Following the sharp correction in October, a late-year spurt may well be on the cards for stocks — and the midterm outcome could be near the forefront of catalysts.
Here’s the lowdown on what Wall Street experts are saying about every possible outcome, and where you should be putting your money.
1. A ‚blue wave‘
The widely expected outcome of a Democratic House and Republican Senate will likely lead to gridlock in Congress.
But fear not, says John Lynch, the chief investment strategist at LPL Financial.
„The stock market tends to like gridlock better because it takes away the extremes and does not disrupt the status quo,“ Lynch said in a note. He added that if you believe the GOP’s biggest policy achievement has been tax cuts — and it arguably has been — a gridlocked Congress that changes little should not be a big market mover.
Historically, markets have not remained calm with the combo of a Republican president and divided government, said Lori Calvasina, the head of US equity strategy at RBC Capital Markets. This time, however, investors have expected (and likely priced in) the blue-wave outcome, following the turmoil that ensued in October.
One sector that would benefit from gridlock and no major policy changes is healthcare, according to analysts at Bank of America Merrill Lynch. Their recommendation is even more granular: a blue House and red Senate would be positive for facilities and Medicaid managed-care organisations, but negative for pharma and biotech stocks.
2. The status quo with a red House and red Senate
In this scenario, investors can expect Congress to continue enacting Trump’s agenda, including deregulation and more fiscal stimulus.
„Continued Republican control could mean more stimulus, which should bear flatten the curve, tightening swap spreads and widening TIPS breakevens,“ said Michael Hanson, the head of global macro strategy at TD Securities.
This outcome is considered stimulative to the US economy, and could lead to even more gains for the dollar, Hanson added. On a cautionary note, the dollar could hit its top tick by the end of the year, especially against other reserve currencies like the euro and the yen. That’s because the long-dollar trade is already well populated.
3. An unexpected ‚red wave‘
Never say never: Republicans could defy the polls and widen their majorities in the House and Senate.
RBC’s Calvasina sees this outcome as bullish for stocks because bigger tax cuts and fiscal stimulus will become a greater possibility. She added that these gains, though likely, will be short-lived if Republicans don’t prioritize tax reform in the run-up to the 2020 elections.
Investors can peer into Goldman Sachs‘ basket of stocks most exposed to tax reform, which contains companies including Chesapeake Energy, General Motors, and Eli Lilly. Goldman thinks these companies will generate the highest return on invested capital. It refers to this as „growth investment,“ defined as R&D plus capex in excess of depreciation.
Defense stocks were a top sector pick for a Republican-dominated government among investors polled by RBC.
Government spending on defense has surged under Trump, and rose in 2017 at its fastest year-on-year rate since 2010, according to Bureau of Economic Analysis data. Lockheed Martin, Raytheon, and Northrop Grumman were among the companies Goldman singled out as having at least 20% revenue exposure to government spending.
4. An unexpected ‚blue tsunami‘
Democrats reclaiming the House and the Senate would be the worst-case scenario for stocks and risk assets in general, according to UBS.
Investors can expect „extreme gridlock“ and slower regulatory relief, according to Mike Ryan, the chief investment strategist at UBS.
In the event of a broader risk-off sell-off, Bank of America Merrill Lynch advises owning consumer staples.
Calvasina agrees that this outcome would be bearish, since it would raise investor worries that a Democratic president would return in 2020, or that impeachment proceedings would begin. Large-cap healthcare stocks could take a hit if investors begin to worry about drug-pricing regulation.
Bank of America analyst Michael Cherny expects a Democratic sweep to ramp up talk of Medicare for All, a single-payer system with a national insurance scheme that covers all Americans. The actual implementation of such a policy is unlikely, but could spell trouble for pharmacy-supply stocks like CVS, Walgreens Boots Alliance, and Express Scripts.
Bonus outcome: No result by Wednesday
If enough races are too close to call and the balance of power in Congress is unclear by Wednesday morning, expect stocks to slide, Calvasina said.
A similar scenario played out in 2000, when the results of presidential and congressional elections were unsettled for about a month. Stocks had already been falling as the tech bubble deflated, but the election overhang made things worse.
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Source: Business insider