Investors are optimistically moving forward with uncertainty following Tuesday’s midterm elections.
- Tuesday was election day, and despite expectations of a major Republican upset, the current expectation is that Democrats will outperform expectations and potentially keep the Senate and lose fewer House seats than expected.
- As we previously reported, analysts were predicting a market rally as a divided government would benefit the equities market.
- The Dow Jones Industrial Average is down more than 500 points or 1.5% since its peak midday Tuesday—a small but notable decline after its October gains.
- Gridlock benefits equities markets and the uncertainty is hurting hopes of a market rally in the coming weeks.
Why it’s Important
As we previously mentioned, a Republican victory in Congress will result in a split government, gridlocking legislation through 2024, and decreasing major legislative changes. As Reuters reports, split governments are historically correlated with positive market performance. But it is not certain that Republicans will take power in Congress.
In this instance, most financial analysts would prefer gridlock. As Barron’s says, “it means fewer policy changes and less risk to individual sectors such as healthcare or energy from one party’s political priorities. Major tax code changes are also unlikely.”
Democrats maintaining power over the executive and legislative branches would leave open the opportunity for new corporate tax increases, more federal spending, and more interest rate hikes.
“A strong performance by Republicans had been seen as likely to rally investor concerns about higher fiscal spending exacerbating inflation and raise the chances of the party freezing spending via the debt ceiling, analysts at Morgan Stanley wrote this week. That could support a rally in 10-year Treasury bonds and help stocks extend their recent gains,” says Reuters.
Backing up a Bit
A Republican hold over the House or Senate will likely also mean a reduction in tech and climate change investments for the next two years, although current laws like the Inflation Reduction Act are unlikely to be reversed. It is expected that a Republican-controlled House will ramp up investigations and litigation against the Biden administration’s policies.
Renewed bi-partisan interest in domestic job creation may open up tech opportunities that create jobs on U.S. soil though.
The predicted market rally still has a chance of coming to pass in the coming week even without total gridlock. “A split Congress, with Republicans winning the House but the Senate staying under Democratic control would likely result in a ‘mild rally,’ … A Republican sweep of both houses would likely produce the same result,” says MarketWatch.
Barron’s warns that split governments can also have a negative impact. “Split rule also brings the risk of political brinkmanship interfering with the basic functioning of government. Congress will need to compromise on a federal budget and will have to raise the debt ceiling around the middle of 2023. A government shutdown amid drawn-out fights over either could be painful for investors, at least temporarily. Divided government could also mean a slim chance of fiscal relief in a recession. In an unstable world, having a government that actually works might be a good thing.”