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If Republicans – who have been leading in polls and betting markets – win control of either the House of Representatives, the Senate, or both, it will result in a split government with the presidency under Democrat Joe Biden.
Here are some potential market implications from Tuesday’s vote:
** With a Democrat in the White House, the best market performance has come when Republicans held either the House, Senate or both.
Average annual S&P 500 returns have been 14% in a split Congress and 13% in a Republican-held Congress under a Democratic president, according to data since 1932 analyzed by RBC Capital Markets. That compares with 10% when Democrats controlled the presidency and Congress.
The S&P 500 is down 20% this year.
** Many strategists are also quick to cite the stock market’s perfect post-midterms track record: The S&P 500 has posted a gain in each 12-month period after the midterm vote for 19 straight occasions since World War Two, according to Deutsche Bank (ETR:DBKGn).
Over the past 18 political cycles, the S&P 500 has risen by an average of over 15% in the year following the midterm vote, according to Oxford Economics.
Investors give a number of possible reasons for the post-midterms tailwind, with some saying the vote tends to bring a clearer policy outlook.
But some are wary that the streak is at risk this year, given concerns that the economy is heading into a recession.
** While investors tend to favor political gridlock, one fallout of split government may be a bruising fight over raising the U.S. debt ceiling that could stoke concerns over a U.S. default and spur market volatility.
“We believe the divided government scenario that serves as our base case will lead to fiscal fights similar to those we saw in the 2011-13 period of divided government,” BTIG said in a recent note.
** Healthcare, energy and defense are among the areas of the stock market that could see the most volatility in the wake of the election.
A Republican win could alleviate concerns over Democrat initiatives to push through tougher policies on prescription drug prices, potentially supporting pharmaceutical and biotech stocks. A GOP win could also raise expectations for higher defense spending and more favorable legislation for the fossil fuel industry.
A surprise Democratic win could aid shares of clean energy and cannabis companies, given expectations the party would more likely favor legislation friendlier to those industries.
** Strategists at Morgan Stanley (NYSE:MS), including Mike Wilson, wrote on Monday that a Democrat win could send Treasury yields higher and strengthen the dollar, reflecting the view that potentially higher fiscal spending could exacerbate inflation and force the Federal Reserve to raise rates higher than expected.
