Analysis: U.S. midterm elections may add more risk to shaky stock market

The United States Capitol building is seen in Washington, United States, on September 4, 2022. REUTERS/Elizabeth Frantz

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NEW YORK, Sept 13 (Reuters) – Another potential source of stock market volatility looms in an already difficult year for Wall Street: U.S. midterm elections looming that will determine which political party controls Congress.

Republicans are expected to make gains on the Nov. 8 vote, setting up a scenario favored by many investors because it would split the government now controlled by President Joe Biden’s Democratic party. Historically, a divided government has been more stock-friendly than when Democrats control both the House and Senate along with the presidency. read more

But the Democrats’ chances for Biden have been improving, according to betting and polling websites. A closer race has Wall Street worried that Biden could raise taxes on investors and corporations while tightening regulations in areas like health care and banking.

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The growing uncertainty ahead of the election “would potentially be a source of uneasiness in the markets,” said Walter Todd, chief investment officer at Greenwood Capital.

As of September 12, Republicans had a 74% chance of taking control of the House, up from 88% on July 13, according to data analysis website FiveThirtyEight. It gave Democrats a 69% chance of controlling the Senate, while Republicans’ chances were over 50% at the end of July.

On betting website PredictIt, the cost of a contract predicting Republicans will win the House fell to 75 cents from more than 90 cents at the end of June. The contract pays $1 if correct.

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Election worries haven’t made much noise in markets so far this year, with investors consumed by huge rate hikes from the Federal Reserve to rein in rising inflation. read more

Voting concerns could become more prominent as November approaches. Many investors believe that a divided government makes sweeping reforms less likely, which keeps the investment environment more stable.

“The market tends to like to be stagnant,” said Nadia Lovell, senior US equity strategist at UBS Global Wealth Management. “I think it’s fair to say that a divided government is what investors right now expect and are positioned for.”

Historical data showed stocks tend to do better in periods of divided government, though investors cautioned that data is limited and markets have generally risen over time, regardless of government composition.

Average annual returns for the S&P 500 have been 14% in a divided Congress and 13% in a Republican-controlled Congress when a Democrat is in the White House, according to data since 1932 analyzed by RBC Capital Markets. That compares to 10% when Democrats controlled the presidency and Congress.


In a report this week, Goldman Sachs analysts said the outcome “appears closer,” with early election results and some polling “suggesting Democrats are in a better position than they were a few months ago.”

A Democratic Congress would give Biden a better chance to enact more of his agenda, perhaps including proposals to raise top tax rates on businesses, capital gains or individual income, according to Goldman. Investors generally view such fiscal measures as unfriendly to markets.

Stocks in some industries could be particularly volatile if elections start to tip Democratic. For financial services, a Republican victory in Congress represents “the most beneficial scenario … as the Republican Party would resist efforts to restrict the activities of large financial institutions,” UBS analysts said in a report.

Similarly, for health care, most laws affecting the industry “are unlikely to make much headway if either house of Congress passes Republican control,” according to UBS.

The financial sector of the S&P 500 (.SPSY) fell 11.7% this year at the end of Monday, while the health sector (.SPXHC) down 7.1%. The S&P 500 is down 13.8% so far this year.

Despite the potential for short-term volatility, the market has generally performed well in the 12-month period following the midterm votes.

Since 1950, the benchmark S&P 500 index (.SPX) has risen in the 18 12-month periods after the midterms, according to LPL Financial

“There is political and policy uncertainty heading into the midterms that clears up after the election and stocks tend to see a relief rally from that,” said Jeffrey Buchbinder, chief equity strategist at LPL Financial.

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Information from Lewis Krauskopf; Edited by Ira Iosebashvili and David Gregorio

Our standards: The Thomson Reuters Trust Principles.

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