November 7, 2018
As was widely expected, Democrats regained a majority in the House of Representatives while Republicans increased their control within the Senate. This result reflects a very divided American electorate — the House and Senate have moved in opposite directions during a midterm only three times since World War II and for the first time in 36 years.
A divided Congress reduces some of the uncertainty regarding domestic policy and we see areas where bipartisan cooperation is certainly possible. However, broad bipartisan consensus on major new legislation is highly unlikely. Historically, domestic stocks have performed well after midterm elections regardless of the outcome over the subsequent three-month, six-month and 12-month time horizons, though we caution that investment markets can certainly diverge from prior experience.
The election outcome
As prediction markets and pollsters anticipated, America’s midterm election resulted in the Democrats taking the U.S. House of Representatives and Republicans holding the U.S. Senate. A week before the election, prediction markets had given the Democrats a roughly 70 percent chance of taking the House and gave the Republicans an almost 80 percent chance of holding the Senate, based on data from PredictIt.org. Gubernatorial results also favored Democrats, which was expected.
With several elections still in “too close to call” territory, Democrats could pick up more than 30 seats in the House, which is a surplus to the 23 they needed to take control of the House for the first time in eight years. In the Senate, Republicans increased their majority, again with a few elections yet to be called.
Both sides are declaring victories, of sorts, and these results are consistent with recent political volatility — this is the third time in the last 12 years that the House majority shifted parties. Perhaps the most significant outtake of these results, from an electorate standpoint, is the stark divide among voter groups. Divided election results, based such things as education levels, gender, rural-urban residence, age and race, were prominent in midterm polls.
Historical impact on the economy and markets
While drawing on historical results is not always indicative of what may emerge now, it is useful to look at precedent following midterms. According to data compiled from FactSet Research Systems, the S&P 500 has historically outperformed in the 12 months after midterm elections, compared to the average performance of the S&P 500 in non-midterm years.1 In fact, the last time the S&P 500 had a negative return during a full year after a midterm election was in 1939. It should also be noted that the party (or parties) controlling Congress has historically had no noticeable impact on overall equity market performance.
The historical outperformance of the S&P 500 Index in the three-month, six-month and 12-month periods after a midterm election, compared to other similar time-periods in non-midterm years, could have several contributing factors. At least one factor may be investors’ reduced uncertainty regarding the policy direction in the United States, regardless of the election’s outcome. Additional details are provided in the table below.
Midterm stock market performance since 1962
|Year of midterm||President||Party||President’s party: House seats||President’s party: Senate seats||S&P 500
| Nov-Jan (3 months)
| Nov-Apr (6 months)
| S&P 500
| Nov-Oct (12 months)
|1962||John F. Kennedy||D||-4||3||17.1%||23.5%||30.9%|
|1974||Gerald Ford (Nixon)||R||-48||-5||4.2%||18.1%||20.5%|
|2002||George W. Bush||R||8||2||-3.4%||3.5%||18.6%|
|2006||George W. Bush||R||-30||-6||4.4%||7.6%||12.4%|
|Average seat change:||-22||-3|
|Flip to Republican control|
|Flip to Democrat control|
Data source: FactSet Research Systems.
*The average monthly price return of the S&P 500 in three-month, six-month and 12-month increments, starting in the month of November of every year since 1963 where there wasn’t a midterm election held in that November.
The potential direction of policy
A politically divided Congress likely means the ongoing use of continuing resolutions — which extend the previous year’s budget into the next year — in order to fund the government. Also, a divided Congress increases the risk of future government shutdowns due to potential disputes over taxation, spending and the debt ceiling. That being said, we view the risk of a government shutdown primarily as headline risk, with the potential for heightened short-term market volatility, but with little lasting effect on markets or the economy.
Broad bipartisan cooperation on new legislation is unlikely. However, infrastructure is one area where we see the potential for a bipartisan deal between a Democrat-controlled House and a Republican-controlled Senate. An infrastructure package may provide an additional policy stimulus directly benefitting the U.S. economy and could provide further support to our slight preference for U.S. equities over non-U.S. equities.
Overall, a divided Congress means a more certain policy direction, with most of U.S. policy being driven by the White House. We see the White House’s key policy agenda largely unaffected by the election since Congress needs a two-thirds majority in both Houses to take power away from the President on trade and tariffs. Deregulation should also continue because this is primarily driven by the executive branch.
Our view: The potential agenda of a divided Congress
|Issue||Policy||Potential market impact|
|Healthcare||Potential action on drug pricing||Any legislation passed would likely be limited|
|Trade||Likely to approve trade deals, but unlikely to challenge the President||Trade policy remains driven by the White House|
|Immigration||Potential to take action on immigration reform||No direct market impact, but will impact the 2020 elections|
|Taxes and spending||The status quo will continue||Reduces uncertainty|
|Regulation||The White House’s deregulatory agenda will continue||Reduces uncertainty|
Trump White House
|A divided Congress won’t take on the White House||Reduces uncertainty|
Source: U.S. Bank Asset Management Group analysis. Date: November 2018.
Our investment guidance
The election results remove some of the uncertainty regarding the direction of domestic policy in the United States. Most of the impact from the midterm election appears to be centered on individual sectors like healthcare (three states voted to expand Medicaid coverage), energy (a proposition in Colorado to restrict drilling was defeated) and some considerations regarding infrastructure.
We continue to focus on three central issues impacting financial markets: Some major central banks shifting to a more restrictive set of actions (unaffected by midterm results), global growth slowing (indirectly impacted by midterm results), and trade policy, which could be impacted by these results. Given a weaker backdrop for global economic growth and the 2020 presidential election a few short years away, the Trump administration will have to decide if they want to continue with existing and future tariffs in an attempt to draw China to the negotiating table, or if Democrat advancements in the House and gubernatorial elections challenge that position. In addition to trade with China, recasting the North American Free Trade Agreement (NAFTA) is another near-term consideration and other countries and regions await domestic trade decisions. Investors have at least partially linked the potential for the global economy to resume an upward trajectory with trade agreements, and with the American electorate focused on the economy, the administration’s decisions on Chinese trade will be highly impactful.
As we await further clarity on trade policy, we continue to have a balanced outlook for capital markets heading into year-end and the start of 2019. We are seeing some deterioration of global growth that could feed into corporate earnings and market sentiment, but the magnitude and duration of economic weakness is not strong enough to change our balanced view. Further, several positive scenarios for the global economy and capital markets could emerge and we will continue to take a global view and consider all outcomes when shaping our views on your behalf.
We will update you on developments and encourage you to engage with your advisor should you have any questions about your unique situation.
1 The average monthly S&P 500 price return since 1960 is 0.64 percent. The average monthly S&P 500 price return in the 12 months following a midterm election (from the beginning of November to the end of October) since 1960 is 1.35 percent.
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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.
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