US Midterm Elections: What is the outlook for markets?

US Midterm Elections: What is the outlook for markets?

Tue 06 Nov 2018

The US goes to the polls today for midterm elections. Every seat of the lower chamber (the House) is up for election (as it is every two years!), while a third of the upper chamber (the Senate) will also be voted on (Senators are elected every six years). For comparison to the UK Parliament, the House is somewhat like the Commons, with the Senate ratifying decisions in similar fashion to the Lords but with much more oversight.

Usually midterm turnout is pretty low, however with politics in the US becoming hyper-partisan turnout is expected to be significantly up, although probably not as high as in a presidential year. Midterms are often described as a referendum on the President, and have historically been difficult for the party in power. With Trump having a high disapproval rating, Republicans are generally on the defensive in the House, where Democrats are expected to win the 23 seats they need to take back control. However due to a terrible map for Democrats in the Senate (they are defending several seats in states that Trump won in 2016, while Republicans aren’t defending any states won by Clinton), Republicans are expected to hold the upper chamber (currently 51-49) and could even gain 2-3 seats. Even if Democrats pick up a seat, Mike Pence as Vice President would have a deciding vote on any 50-50 votes, effectively giving Republicans control.

To my mind there are really only two realistic scenarios: Republicans in control of both the House and the Senate, or Democrats gaining the House with Republicans keeping the Senate. The Democrats would need a ridiculous run of form for a net gain of two seats, and while the House is clearly difficult for Republicans, the clustered nature of Democratic voters, the older demographic of Republican voters who are more prone to turning out, plus well known gerrymandering predominantly by Republicans (although Democrats are also guilty of this) could override an expected Democratic enthusiasm advantage. That said at the time of writing FivethirtyEight, generally considered one of the higher quality forecasters, who gave Trump a much greater chance in 2016 than many others, gives Democrats a marginally greater chance in the Senate than Republicans in the House due to the tendency of Senate seats to correlate. This phenomenon is not so prevalent in House seats, increasing the chances of a wave to either party in the Senate by bumping up the probabilities of a tail event, and thus the chances of an upset.

What would be best for markets? Everyone was surprised when Republicans gained control of all three legislative branches in 2016, and with a Democratic House priced in, Republicans holding onto the House would likely see markets respond well initially. Further markets don’t like gridlock, preferring on party or the other to be able to go ahead with their legislative agenda. That said, from our analysis there isn’t an awful lot of areas where House legislation could improve things for businesses. Republicans have already passed massive tax cuts, and although they are considering more, any further changes would be marginal by comparison. Changes to business regulations are generally being carried out by executive orders and at department level, which will generally continue without input from Congress. The other area Republicans may have another shot at is repealing the Affordable Care Act, although they failed last time even when using a budget reconciliation process in the Senate to make it a 50-50 vote (most of the time 60 votes are needed to avoid the dreaded filibuster), so may struggle again (although there will be fewer renegade senators such as the late John McCain this time). Further it isn’t clear that a repeal would be all that beneficial to equities in the way that the tax cut was.

What would Democrats do with House control? Well they can’t do an awful lot, as anything remotely partisan wouldn’t get through the Senate, never mind avoid a Trump presidential veto. There are suggestions that a Democrat led House will seek to subpoena members of the Trump election team and ‘air the dirty laundry’, further pushing the narrative that Trump colluded with Russia to win the 2016 election and so turn the public against him. The issue for Democrats is there is very little chance of impeachment given the need for a supermajority in the Senate, and there is the risk they could look solely like the party of obstruction. I expect they will hold some hearings to in an attempt to further discredit Trump, while leaving the real investigation up to special counsel Robert Mueller. There may be concerns that these hearings could prevent Trump Administration figures from properly carrying out their duties, but again is this really going to be negative for markets? From another perspective, perhaps a realisation that co-operation is required between Republicans and Democrats could in some way reduce Trump’s appetite to carry out some of his more market unfriendly agenda, such as ramping up trade war with China. That said I don’t actually expect any change from Trump, who is more likely to continue on regardless and castigate anyone opposing his plans.

Before the last election there was a lot of talk about how politics doesn’t affect markets in the long term. I think there has been an acknowledgement since that this is a little naïve, and that significant changes from the status quo, such as the Republican sweep in 2016, will have an effect, certainly in the medium term. However neither of the two scenarios painted here would do much to change the status quo now, so there isn’t much to be gained by markets from either outcome.

 

PS for some fun I have made some predictions for the House and Senate (which don’t necessarily align with the Political Polls tweet above). For the Senate I give my guesses on a state-by-state basis for anything remotely considered a toss-up, while for the House I’ll just give the overall figure:

House:

Democrats 237

Republicans 198

 

Senate:

Republicans 52

Democrats 48

 

Arizona: With no incumbent Kyrsten Sinema (D) quite comfortably beats Martha McSally (R)

Nevada: Maybe due to the wave effect of Sinema doing well in Arizona, Jacky Rosen (D) ousts the incumbent Dean Heller (R), having had a huge fundraising advantage

Missouri: As incumbent Claire McCaskill (D) just holds on against Josh Hawley (R) in a generally reliably red state

Indiana: Incumbent Joe Donnelly (D) was always heavily favoured to hold on against Mike Braun (R)

Florida: Rick Scott (R) upsets incumbent Bill Nelson (D). As Governor, Scott didn’t have much of an incumbency issue to deal with and was extremely well (self) funded in a state where more and more retirees are heading and where Latinos vote Republican

North Dakota: Incumbent Heidi Heitkamp (D) was always going to struggle to hold on in such a ruby red state, losing to Kevin Cramer (R)

Montana: Perhaps the surprise of the night as incumbent Jon Tester (D) is ousted by Matt Rosendale (R). Trump’s rallying of the base against Tester really paid off here, and it was another example of adjacent states correlating

Texas: Come on, there was never going to be a Democratic pick up in Texas, as incumbent Ted Cruz (R) eases home against 2020 potential Democratic presidential candidate Beto O’Rourke (D)