The impact of the results on the market looks likely to be mixed. (ddp)

With the result in two dozen House seats yet to be disclosed at the time of writing, it looks likely that the Republican Party will hold a narrow majority in this chamber. Democrats may retain control of the Senate after winning an open seat in Pennsylvania, pending results in Arizona and Nevada. Georgia is headed for another Senate runoff.

The impact of the results on the market looks likely to be mixed in our view.

A divided Congress, assuming Republicans gain control of the House and Democrats retain the Senate, would likely block further bold fiscal moves. With Democratic control of both the House and the Senate, Democratic President Biden was able to push through several large fiscal packages, including USD 369bn in spending on climate and energy policies. Additional major steps look less likely in a divided Congress. Notably, Biden has voiced support for a windfall tax on oil and gas companies, which he has accused of “war-profiteering.” He recently urged companies to lower prices or invest more in boosting domestic production—warning that if they fail to do so “they’re going to pay a higher tax on their excess profits and face other restrictions.” Such policies, which would have already been hard to pass even with a Democratic-controlled Congress, may now be further out of reach.

The greater political clarity that follows midterm elections—whatever the outcome—has tended to lift stocks. Since 1982, the S&P 500 has moved higher in the 12 months following the midterms on all 10 occasions—with an average rally of around 13.5%. Of course, this year could break this trend, given the various headwinds facing markets—including stubbornly high inflation, aggressive central bank rate rises, and heightened geopolitical tensions. However, increased visibility on the political outlook could prove helpful.

Federal Reserve policy, rather than fiscal policy, will remain the main driver of markets in our view. There have been large market swings in recent months on shifting perceptions of the outlook for Fed policy. The S&P 500 fell 2.5% on the day of the Fed’s most recent policy meeting, which pointed to a higher terminal rate than previously expected. The pace and peak in rates look set to remain the major preoccupation for investors. As election results continue to come in, futures in the S&P 500 are down just 0.3%—pointing to a relatively muted response from investors so far.

So, while elections have consequences, it’s hard to point to decisive changes from this round. Stepping back, we suggest investors avoid letting their political views impact their investment allocations and instead stick to their long-term plans. We do not yet see the conditions in place for a sustained equity rally, with the risk-reward outlook over the coming six months looking unfavorable. As a result, we favor hedging near-term risks while retaining upside exposure. Where adding exposure, we prefer defensive sectors, such as healthcare and consumer staples.

Main contributors - Mark Haefele, Thomas McLoughlin, Christopher Swann, Vincent Heaney, Jon Gordon

Content is a product of the Chief Investment Office (CIO).

Original report - Close race for Congress points to mixed market impact, 9 November 2022.