US Midterms - overview and likely market reactions

Tomorrow, November 6th, the U.S. will vote in their midterm elections which are a very important milestone for policy making in the 2 years to come for the running president.

Much is at stake in this year’s midterm elections – issues include trade, government spending and taxes, immigration, economic policy and regulation, and some of the president’s positions.

Today we provide a brief overview of these elections and what are the likely effects of results to the stock market.

What are the US midterm elections?

Held at the mid-point of a presidency every four years, members of Congress, the legislative branch of the US government, face re-election. Congress is split into two branches: the House of Representatives and the Senate.

All 435 members of the House of Representatives are up for election every two years, with 35 of 100 seats of the Senate up for election. Members of the Senate serve staggered six-year terms.

Who controls Congress at the moment?

The Republicans, the party of the president, control both the House and the Senate.

They hold 240 seats in the House compared with 195 for the Democrats, with 218 needed for a majority. The Democrats need to flip 23 seats in order to take back the House.

In the Senate the Republicans hold 51 seats compared with 49 for the Democrats. Fifty-one seats are needed for control of Senate. To take back the Senate, the Democrats need to defend their existing 26 seats and win two extra from the Republicans.

Why are the midterms important?

The election will decide if the Republicans remain in control of Congress and therefore the legislative process.

Some of President Trump’s key agendas and campaign promises, such as the repeal of Obamacare, could be revived if Republicans hold control.

Losing control of Congress makes it more difficult to pass bills into law.

Only twice since 1966 has the ruling party picked up seats:

1998 – the Republican party’s attempt to impeach President Clinton galvanised support for the popular Democrat president.

2002 – the country rallied behind its president following the September 11 attacks.

What are the polls showing?

A study by the Wells Fargo Investment Institute showed the Democratic advantage in the Generic Congressional Vote has tightened year to date (see chart no 1 below).

At the moment, studies by the institute show that the probability that Republicans remain in control of the House and Senate is 30% whilst the probability that Democrats regain control of both the House and the Senate is less at 20%.

The most probable outcome (at 50%) is that we will have a divided congress in the House (Democrats win) and Senate (Republicans win).

The worst case for markets

If Democrats re-take both House and Senate, although not very much probable, we might have a slow down in the bull market. US stocks have received a substantial boost from Mr Trump’s tax plan and if Democrats controlled both chambers they could undo it. In such outcome uncertainty will prevail and markets don’t like uncertainty.

How have the markets reacted in the past?

Chart 2 below displays the effects on the S&P500 index prior to, and following, past mid term elections. Historically, this has led to equity market corrections in the run-up to midterm elections. Once this uncertainly has been removed following the elections, the S&P 500 index historically performed well.

It does not matter which party was in charge before or after the midterm election, the removal of uncertainty and of contact media attention allows markets to resume focusing on fundamentals.

This is also confirmed from another study by Rathbones. As we can see on the third chart, markets tend to underperform in the period just before the election and generate better returns after the result.

What is the bottom line for investors?

While midterm elections over the years have tended to exhibit positive trends, it is important to remember that each year is different and follows its own path. Midterm elections — and politics as a whole — generate a lot of noise and uncertainty. But the reality is that long-term equity returns are generated by the performance of individual companies over time. Elections can cause short-term spikes in volatility; the key is to maintain a long-term focus.



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