Strong Showing from Republicans in Midterm Elections Could Spark Stock Market Rally

U.S. voters go to the polls in midterm elections on Tuesday with the House of Representatives and the Senate at stake. Republicans are gaining momentum ahead of the vote. However, there are still three outcomes at stake that could influence the financial markets over the short-run and perhaps the next two years remaining years of President Joe Biden’s term.

The three outcomes include:  A Democratic victory with the party maintaining control of the House and Senate. A Republican sweep with the party taking control of both the House and Senate. The third outcome is a split vote with either party controlling the House or the Senate.

Some Investors Would Prefer Gridlock

Let’s take a look at the third outcome first. Investors are leaning toward a big Republican wave in the mid-term elections. If Republicans take at least one chamber of Congress – the House or the Senate, that would likely result in gridlock. According to data from Edelman Financial Engines, this would be the situation the market would love.

Historical data shows that the S&P 500 had an annualized return of 16.9% since 1948 during the nine years when a Democrat was in the White House and Republicans had a majority in both chambers of Congress. That compares to 15.1% during periods of full Democratic control in years when there was a unified GOP government, according to Edelman Financial Engines.

“Investors are more happy when politicians bicker but don’t actually enact any new laws that may hurt corporate profits,” CNN wrote.

But Gridlock Isn’t Always Good

Although the historical studies point to favorable returns if there is gridlock, each case has to be looked at individually because of various situations and circumstances. For example, a low interest rate environment that may have had nothing to do with the government, and everything to do with Federal Reserve policy may have driven those returns.

Gridlock this time may be bad of stocks this time if it means a longer recovery from a recession. Then there is the debt ceiling issue that could lead to a lower credit rating for the United States.

Political headlines are often just noise for the stock market. Historically speaking we could see a short-term reaction to the news, but stocks could just go up over the long-run because of economic conditions, no matter which party control the White House and Congress.

Generally Speaking…

The common assumption is that Republicans represent business and the Democrats represent the people. Whether that’s a valid conclusion is debatable.

If Republicans take control for the next two years, business conditions could improve especially in the oil industry. Republicans tend to lead toward lower corporate taxes and few regulations that tend to help companies and the economy grow.

Democrats tend to favor social programs funded by fiscal spending. And in order to pay for them they raise taxes and increase regulations that tend to stifle growth.

All things being equal, meaning no inflation, no rate hikes, and no recession, a Republican sweep of the House and Senate would be favorable for business and the stock market.