Investment Strategy

Midterm elections preview: Potential outcomes and market implications

Oct 28, 2022

With just two weeks to go before voters hit the polls, consider this breakdown of what’s at stake and why it matters for portfolios.

Ian Schaeffer, Global Investment Strategist

Federico Cuevas, Global Investment Strategist

 

Our Top Market Takeaways for October 28, 2022.

Market update

About that recession

 

The (bear) market rally continued for the first half of the week, but a few notable earnings misses (namely from a handful of tech giants) threw cold water on the winning streak—the slowdown seems to be here for tech.

Nevertheless, coming into Friday, the S&P 500 (+1.5%) kept some gains, while U.S. Treasury yields came off their highs across the curve (2-year, -23 basis points to 4.28%, and 10-year, -30 basis points to 3.92%).

In economic data, the latest U.S. GDP print showed that the economy rebounded in the third quarter (+2.6% quarter-over-quarter) after contracting for the first six months of the year. The biggest boost came from net trade (it added 2.8%, driven by solid exports and a drop in imports). Otherwise, real consumption came in line with consensus, while housing was the big laggard—falling 26% quarter-over-quarter.

Central banks are still adamant on getting inflation down, but both the European Central Bank and the Bank of Canada struck a more market-friendly tone this week. Next week, we’ll see if the Federal Reserve follows suit. Markets expect another 75-basis-point hike in the United States.

This week’s note focuses on a key event that will be top of mind for all Americans through early November: the World Series.

Just kidding. We’re talking about the midterm elections on November 8. Read on for our thoughts on what it could mean for investors.

Spotlight

Our expectations for midterm elections

 

Two weeks away from midterms, and investors wonder what consequences might come along with the big day. Here are a few key points on the range of possible outcomes.

1) What is at stake? Up for grabs are control of Congress, key state and local offices, and a number of ballot initiatives in states across the country. Many voters seem to be focused on the economy, as inflation remains near a 40-year high and Americans feel the pinch in their wallets. The officials elected to Congress and state and local offices will have much influence on what the current White House administration can accomplish in the remainder of its term.

2) What do the odds look like? Democrats hold both houses of Congress by very slim margins. Currently, Democrats control the House with 220 seats, while Republicans hold 212 seats. Over in the Senate, there’s a split of 50/50 with Democrats holding control due to Vice President Harris’s tie-breaking vote.

These graphs show the compositions of the House of Representatives and the Senate, by party, as of October 2022. The left-hand side graph shows that the House of Representatives is composed of 220 Democrats, 212 Republicans and three vacancies, while the right-hand side graph shows that the Senate is equally divided (50/50).

All 435 House seats will be contested in the midterms. Given that Democrats hold only an eight-seat majority in the House now, Republicans would not need a major upset to take the House. In the currently evenly divided Senate, only 34 of the 100 seats will be up for grabs in the midterms (Senate terms are six years); 21 of those seats in the 2022 election cycle are currently held by Republicans, with an additional five Republicans set to retire this term.

The latest polling and most projections suggest that Republicans will regain control of the House, while Democrats will hold on to the Senate. Hence, a divided government. Uncertainty around the actual outcome remains, but we fall back on a couple of historical observations (as well as more recent developments) to draw this assumption:

  • President Biden is at a 41% approval rating (and less than 25% of people strongly support him). History shows that when a president is under a 50% approval rating, the incumbent loses on average 36 seats on the House.
  • Post-World War II, the incumbent party has on average lost 12 seats in the House and one or two in the Senate in the first midterm after a new president’s election. In the past 30 years, Clinton lost 52, Bush lost 30, Obama lost 63 and Trump lost 40. And, in fact, a newly elected president has only gained seats twice in the last century (1934—the Great Depression, and 2002—9/11).
  • In terms of recent polling, persistently high inflation has appeared to erode support for Democrats. Economic issues such as the ongoing cost-of-living squeeze, and social issues such as the Supreme Court ruling on abortion could be swing factors for some voters. And, as the induced slowdown by the Fed broadens, these perceptions could become even more negative.
This chart shows the misery index and consumer opinion from January 31, 1976, until September 30, 2022. The first data point for the misery index and consumer opinion came in at 14% and 5.8, respectively. From there, the misery index rose to 22% by June 30, 1980, while consumer opinion rose to 33.1 by October 27, 1985. Here, the misery index declined to 7.7% by December 31, 1986, before rising to 12.5% by November 30, 1990. Consumer opinion then declined to 5.8 by December 9, 1992, before it skyrocketed to 47.6 by August 5, 1999. Meanwhile, the misery index declined to 5.7% before rising back to 12.9% by September 30, 2011. Here, consumer opinion declined to a trough of 6.3 by October 19, 2008, before rising to 24.4 and then declining back to 8.2 by November 23, 2011. From there until recently, consumer opinion rose to 37.9 by February 5, 2020, before declining back to 15.5 by April 6, 2022. In the meantime, the misery index declined to 5.2% by September 30, 2019, before rising to 15% by April 30, 2020, and then declining to 11.7% by September 30, 2022.

3) What could different outcomes mean for legislation?

Whatever the outcome, it could have significant impacts on U.S. fiscal policy, tax policy and the overall legislative agenda for the next two years. There are generally three outcomes that could arise out of the midterms.

  • Divided government—Republicans take control of the House, Democrats retain control of the Senate: Most expect the Republicans to pick up a majority in at least one chamber of Congress in two weeks. This outcome is likely to be the least consequential for markets. A divided government—in a way—epitomizes the checks and balances system. A divided government would not be likely to pass any legislation that falls too far from the center of the political spectrum. This means that major legislative packages aimed at higher taxes for individuals or corporations, for example, would likely be off the table for at least the next two years. However, a divided government would also mean that any fiscal rescue package in the event of an economic downturn would be less likely.
  • Divided government—Republicans take control of both the House and Senate: If Republicans secure a majority in both chambers of Congress, many of the key items on the Democratic legislative agenda would likely not be able to make it through Congress. This means that tax increases, legislation on tech companies, fossil fuel regulations, and further bills on climate or the environment will likely all be off the table for the foreseeable future. In addition, while a Republican sweep of Congress could cloud the outlook for any healthcare legislation or Medicare for all, it does not necessarily mean that the recently passed Inflation Reduction Act will be repealed.
  • Democratic sweep—Democrats hold on to their current majority in Congress: While generally considered the least likely outcome, a Democratic sweep could create more volatility in markets. A Democratic sweep could lead to potentially higher taxes or a stricter regulatory environment for businesses. Another two years of Democratic control of Congress could also bring heightened concerns for healthcare or big tech, which have been under increased regulatory scrutiny for the past two years.

 

Investment implications

What could these outcomes mean for investments?

 

The only thing that is granted about elections is that they add uncertainty to the investment outlook. Despite adding a degree of uncertainty, past experiences show that midterm elections tend to have a relatively muted impact on equity markets. The below chart illustrates that the S&P 500 has a tendency to move higher after the political uncertainty declines in the aftermath of midterms.

This chart shows the S&P 500 performance based on party control of White House + Congress (Democrat, Republican, divided, united, total), 150 days before the election until 250 days after the election (index, 100 = election day). The first datapoint for Democrat came in at 105.2, 123 days prior to the election. From there, it declined to 97.4, five days prior to the election, and then rose to 111.9, 251 days after the election. The first datapoint for Republican came in at 101.9, 123 days prior to the election. From there, it declined to 96.5, 18 days prior to the election, and then rose to 110.9, 251 days after the election. The first datapoint for divided came in at 95.9, 123 days prior to the election. From there, it rose to a peak of 114, 173 days after the election, and then declined to 111.4, 251 days after the election. The first datapoint for united came in at 104.2, 123 days prior to the election. From there, it declined to 97.6, five days before the election, and then rose to 111.7, 251 days after the election. The first datapoint for total came in at 99.2, 123 days prior to the election. From there, it declined to 98.1, 17 days before the election, and then rose to 111.5, 251 days after the election.

As concerns around market volatility rise, and we approach election day, we would encourage investors to stay invested and focus on their long-term goals. We are focused on portfolio positioning that may provide a buffer in the event of an economic slowdown. While the Fed continues with its hiking cycle, and more market swings are expected, we would encourage investors to look out for compelling entry points, particularly on sectors that are already set to benefit from the $370 billion in spending from the Inflation Reduction Act, namely clean energy, defense and select industrials.

Your J.P. Morgan team is here to help you put these insights into action for your portfolio.

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Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

All market and economic data as of October 2022 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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  • Past performance is not indicative of future results. You may not invest directly in an index.
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