How might 2022 US midterm elections affect stocks? Here are 3 scenarios.

November 8, 2022

Since 1946, US stocks typically fared better in 6-month period after midterms elections, than six months prior.
Democrats retaining control of Congress may be deemed negative for US stocks, while Republicans wresting control of Congress could be seen as positive for equities.
However, any reaction to this midterm election could be relatively modest compared to the larger driver that is the Fed’s attempts to cool still-hot inflation (and possible trigger a US recession).

History has been kind for US stock markets following the midterm elections.

According to Bloomberg data, for 16 out of the past 19 midterms since 1946, stocks have fared better in the 6-month period after a midterms than the six months before the elections.

Also, take into account the year-end seasonality which typically heralds stock gains.

Over the past three decades, the month of November has seen an average monthly gain of 1.84% for the S&P 500.

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That’s the second-highest monthly average gain going back to 1993, after first-placed April’s 2.28% average monthly climb over that three-decade span.

However, this year could be different.

The US pollical landscape has since changed drastically, with the chasm seemingly growing more polarized with the passage of time.

Also, the macroeconomic backdrop and the resultant central bank response has been unkind to risk assets, to say the least.

After all:

US core inflation (consumer prices that exclude more-volatile food and energy prices) is at its highest since 1982, pending this Thursday’s (Nov. 10th) US inflation data release.
At 6.6% as of September 2022, that core CPI print is still more than triple the Fed’s 2% target (though the Fed’s preferred inflation gauge is the Core PCE).
The US Federal Reserve has already hiked its benchmark interest rates by 375 basis points so far this year, bringing the upper bound of its rates range now to 4% = a level not seen since 2008.
Using current market forecasts, US rates are expected to peak at 5.1% by mid-2023, though that peak could move even higher if US inflation is shown to be stubbornly elevated.

A reminder of what’s at stake in today’s midterm elections: control of the US Congress.

NOTE: Senate + House = US Congress

Up for grabs today:

435 seats in House of Representatives
35 of the 100 Senate seats
36 governorships

Going into this election, Democrats have control of both chambers of Congress, as well as the White House (US President Joe Biden is a Democrat).

Republicans only need to take on 5 seats to claim a House-majority, while only one more seat is needed to take control of the Senate.

Ultimately, markets want to know how the political makeup of Congress would set the incoming fiscal policies, and how such policies would feed into the current inflation outlook as well as the Fed’s expected response.

After all, inflation woes as well as recession fears are very much framing voters’ mindsets as they cast their ballots today.

Such worries have already seen a notable shift away from Democrats, with President Biden’s approval ratings falling in the lead up to today’s elections.

3 scenarios for US stocks

But as for investors and traders around the world, here are some broad outcomes that they might have to content with over the next 24 hours:

If Republicans control both the House and the Senate = S&P 500 may extend recent gains
Republicans are typically associated with tighter fiscal spending.
Less government spending could work in tandem with the Fed rate hikes in subduing red-hot consumer prices.
Hence, we may see immediate gains for US stocks based on the above assumptions, as a Republican stronghold on Congress (and tighter fiscal spending) implies that the Fed may have less work to do in subduing inflationary pressures.
Though whether or not Republicans can actually rein in government spending, especially if the US economy threatens to enter a recession in 2023, would be a different matter.
If Democrats retain control of the House and Senate = S&P 500 may fall further
Democrats are typically associated with looser fiscal spending plans/larger government spending.
Already in the lead up to today’s elections, the party has touted boosting healthcare and childcare subsidies and wage hikes for workers.
These types of measures tend to fan inflationary pressures, which implies the Fed has to raise US interest rates even higher.
As we know, Fed rate hikes have essentially been enemy #1 for US stocks this year.
Hence the simplistic assumption here would be:
More government spending by Democrats = more Fed rate hikes = more pain for US stocks.
Political uncertainty / unclear or contested outcome = S&P 500 could revel amidst the ambiguity and hang on to recent gains
Markets generally dislike uncertainty.
However, uncertainty that preserves the way things are (the status quo) may not be such a bad thing for stocks.
Additionally, US stocks have proven resilient to political unrest, judging by recent history.
Recall how even amidst the January 2021 riots at the US Capitol, the S&P 500 barely budged, going about its merry way towards its all-time high just a hair below 4820 (intraday prices) at the start of 2022.
Still, one could argue how any chaos in Congress might yet trigger a knee-jerk selloff across stocks, with investors potentially entering into risk-off mode and seeking refuge in safe havens (e.g. gold, US dollar, US Treasuries).

Looking at the charts …

To be clear, the S&P 500 remains very much in a downtrend on the weekly timeframe.

And with the S&P 500 already headed for its worst year since the Global Financial Crisis, today’s midterm elections may influence whether its:

year-to-date losses of 20% can be trimmed, or …
the ongoing bear market will be extended in 2023

Heightened macro fears (and downward earnings revisions) may yet see the S&P 500 ultimately retesting its 200-week SMA for support in the mid-3000 region.

Key Resistance and Support levels for S&P 500 after 2022 US midterm elections:

IMMEDIATE RESISTANCE: 3920
(late-October/early-November cycle high, also around its 100-day simple moving average)
STRONGER RESISTANCE: 4000 psychologically-important mark
IMMEDIATE SUPPORT: 3700 region
(last week’s low)
STRONGER SUPPORT: around 3637
(mid-June cycle low)

Overall, I’m inclined to think that any reaction to the US midterm elections are expected to be relatively muted compared to the bigger driver that is the Fed’s ongoing rate hikes which in turn are ramping up recession risks for the world’s largest economy.

Noting that the final tally for this US midterm elections could take days before reaching a conclusive ending, then should leave Thursday’s US inflation report in the driver’s seat for dictating how the S&P 500 would fare over the immediate term.

Article by ForexTime