U.S Midterm Elections and the Markets

On November 6, 2018, U.S. voters will determine whether Republicans maintain control of both chambers of Congress. Up for election are all 435 House seats and 35 of 100 Senate seats. At stake for investors is the impact the midterm elections could have both on corporate earnings and on the U.S. economy. It’s interesting to note that according to Bloomberg since 1946, the S&P 500 has never declined in the 12 months following midterm elections. Furthermore, the S&P 500 has seen an average fourth-quarter return of 7.9% during midterm election years. That being said, I feel comfortable saying we should expect heightened volatility during and after this election season given the current administration and sitting President.

Looking at recent polls we can identify three separate scenarios from most likely to least likely outcome.

Democratic House, Republican Senate: The outcome with the highest likelihood is that of a Democratic House and Republican Senate. With this outcome a decreased likelihood of a second wave of tax cuts would be anticipated. Economic growth could slow as recent tax cuts have certainly been a supportive fiscal policy. This could influence consumer confidence which has been high under current administration.

Republican House / Republican Senate: The outcome with the second highest probability is the Republicans maintaining the majority in both the House and the Senate. That outcome could yield “more of the same”. That should mean continued economic growth, strong consumer confidence, rising interest rates and the return of duration premium to the yield curve.

Democratic House / Democratic Senate: The outcome with the lowest probability, according to the polls, along with the greatest potential impact on the markets is a Democratic sweep. I believe the markets would quickly price in some uncertainty, increased volatility given this outcome was not expected and generally the markets don’t like surprises.

Midterm elections traditionally have had short lived to marginal impact on the markets, but as outlined above this year may be different. Historically, event risk, and specifically political event risk can provide short term opportunities in the marketplace, but as far as its impact on long term fundamentals that is generally a slower moving phenomenon. In this current environment with fundamentals being as strong as they are, I expect the midterm elections to possibly provide some volatile trading sessions and short-term dislocations but the forecast for U.S. growth and the domestic economy continues to support a risk on trade for long term investment assets. We want to emphasize again the value of developing a long-term plan and sticking to it, regardless of who is controlling the ballot box and Washington.