Midterm elections in the USA: impact on the markets
Author - Harald Holzer
The US mid-term elections are finally counted, and the winners determined. In the House of Representatives, the Republics won the majority from Democrats even though a much smaller one than expected. In the Senate the Democrats maintain control possibly even gaining one seat depending on the run-off election in Georgia. What implications does this have on the equity markets moving forward?
History has shown that the stock market under first term Democratic presidents have performed poorly. Presidents Biden first term is no exception to this rule. This by no means implies causation but should be seen more has a historical observation though especially when controlling Congress and the Presidency, a party through fiscal policy can impact economic indicators that do effect stock market returns. Following mid-term elections, stock markets generally have a year-end rally driven by the fact that uncertainty on who will govern over the next 2 years has been removed.
Looking toward history shows that stock markets usually rise strongly in years ahead of Presidential elections. The next presidential elections are in two years, that's for sure, but it is questionable whether monetary and fiscal policy will also play along.
On the one hand, depending on what happens to inflation in the US, the Fed is expected to start reducing interest rates in 2023, which would tick one of the two boxes. On fiscal policy at this time, it is hard to imagine a sharp increase in fiscal spending given the split in the Congress between Democrats and Republicans. It was difficult enough for Democrats to pass major legislation with their slims majorities in the first two years. It is hard to imagine more fiscal stimulus passing now. However, one because that would automatically trigger more fiscal stimulus is a recession with higher payments for unemployment. This scenario however would also lead to a sharp drop in earnings, which in turn would lead to a falling stock market.
We still advise caution despite these historical patterns because the decline in inflation is still not certain and therefore the assumption of declining Fed Funds in 2023 not a given. Additionally, the economy is still slowing, while the pace of deceleration and the depth of a slow down unclear. Until the picture becomes one that confirms a soft landing with inflation declining toward 3 % by the end for year, we remain underweight in stocks and continue to hedge our bond exposure.