How the U.S. midterms could ripple through the stock market

By Lewis Krauskopf

NEW YORK (Reuters) -Investors are turning their focus to Tuesday’s U.S. midterm elections, which will determine control of Congress and could spur moves in everything from energy companies to cannabis stocks.

Republicans have picked up momentum in polls and betting markets and analysts see a split government – with the GOP winning the House of Representatives and possibly the Senate – as the likely outcome possibly hindering Democratic President Joe Biden’s agenda.

Traders also appear to be leaning toward a Republican win: a basket of stocks and other assets tracked by advisory firm Strategas that would be expected to do well after a Republican victory have outperformed a counterpart Democrat portfolio, indicating a roughly 70% chance that Republicans win both the House and Senate.

A split government could result in political gridlock that stymies major policy changes, an outcome that investors see as favorable for equities. Regardless of the winner, past midterm elections have ushered in a period of positive market performance, something investors would welcome after a year in which the S&P 500 has declined by nearly 21%.

Divided government could also, however, pave the way for partisan standoffs over raising the federal debt limit that could usher in worries of a U.S. default.

Here are some areas of the stock market that will be in focus as Americans head to the polls:

DEFENSE Defense spending is expected to rise regardless of how Tuesday’s vote plays out, given geopolitical tensions such as the conflict in Ukraine. But a Republican sweep sets the stage for spending to rise “significantly,” according to UBS Global Wealth Management, versus “moderately” if Democrats retain one or both chambers of Congress. The outcome puts a focus on shares of defense contractors, such as Lockheed Martin or Raytheon Technologies. The S&P 500 aerospace and defense index is up nearly 10% this year.

ENERGY Energy stocks have had a banner year, with the S&P 500 energy sector rising over 60% so far in 2022 while the broader index has slumped around 21%.Policies to encourage more U.S. energy production could result from Republican control of both the House and the Senate, Citi analysts said. While such legislation could be favorable for oil exploration companies, it may weigh on the stocks by pressuring oil prices, Citi analysts wrote. More direct benefits from favorable industry regulations could filter through to shares of pipeline companies, such as Williams Cos, Strategas said.

CLEAN ENERGY With Republicans gaining momentum, any downside for solar and other alternative energy stocks may already be baked in, but a surprise Democratic victory could power the sector higher. The Invesco Solar ETF is down about 6% this year. Legislation favoring “clean energy,” including tax credits and investment, could see support if Democrats maintain control of Congress, according to State Street Global Advisors.

HEALTHCARE Pharmaceutical and biotech stocks may benefit in a Republican victory, after Democrats recently pushed through a law aimed at lowering prescription drug prices. Pharma and biotech stocks as a whole have moved in the opposite direction of betting odds favoring a Democratic sweep, according to Goldman Sachs analysts.

The S&P 500 healthcare sector is down some 7% in 2022, while the S&P 500 pharmaceuticals index is up about 1%.SECURITY A Republican Congress would make border security a “top tier issue,” according to Strategas. While private prisons such as CoreCivic and Geo Group face “a steady stream of negative headlines” during the Biden administration, “the remaining federal policy risks will largely dissipate in a divided government scenario,” BTIG said in a report. CoreCivic is up about 12% this year, while Geo Group is up about 15%.

CANNABIS Cannabis stocks such as Canopy Growth tend to move on regulatory headlines, including prospects for legalization efforts. Odds of friendlier cannabis legislation increase with a Democratic majority, according to Strategas.

The AdvisorShares Pure US Cannabis ETF is down over 55% this year. BIG TECH It’s unclear whether megacap tech company reform has bipartisan support, according to Citi analysts. Therefore Republican victory in the House or Senate “probably means a legislative standstill, implying an incremental positive for the category,” the said.

The tech-heavy Nasdaq 100 index has fallen by roughly one-third this year.

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili)