How investors should think about the midterm elections


The midterm election could be a pivotal moment in American history — but it may not be all that meaningful for the stock market.

Political pundits, pollsters and investment banks mostly agree that Democrats are likely to win the House and Republicans are on track to keep control the Senate. CNN’s Harry Enten predicts in The Forecast that Democrats will win a 17-seat majority in the House but Republicans will maintain their slight edge in the Senate.

Gridlock in Washington would prevent the government from enacting new policies, keeping the status quo — at least from Wall Street’s perspective. A split decision from the midterms would probably keep America’s fiscal, trade and regulatory policies on the same trajectory.

“Divided government is increasingly the most likely case, with limited ramifications for markets,” Morgan Stanley strategists Michael Zezas and Meredith Pickett wrote to clients last week.

Barclays agrees. “A Democrat win of the House would likely lead to government gridlock,” the firm wrote last week. “No market-moving legislation is likely to pass through Congress.”

Brexit and the 2016 American presidential election proved that investors must prepare for the unexpected. Those shocking electoral outcomes produced dramatic and surprising reactions in financial markets.

With that in mind, Barclays warns that an unlikely “Blue Tsunami” that carries the Democrats atop both the House and Senate would be a “negative” for the US stock market.

Without tax cuts and deregulation to look forward to, investor sentiment would be hurt by calls for impeachment and investigations, Barclays argues.

What about the trade war? Barclays says a huge defeat for Republicans could result in vastly different outcomes on trade. It’s possible losing control of Congress would force President Donald Trump to rethink his protectionism. On the other hand, Barclays said Congressional investigations could spark a “more confrontational approach” on trade from the White House.

Morgan Stanley argues that a “blue sweep” in November would be negative for pharmaceutical companies because of heightened risk of a crackdown on drug prices. But the firm said a Democratic House and Senate would be “neutral” for the market overall.

On the other hand, investors may cheer if Republicans maintain control of both houses of Congress. Trump’s pro-business policies of low tax cuts and deregulation would be reinforced.

Barclays called this scenario “very risk positive” because it would “embolden” Trump’s America First agenda and probably lead to more tax cuts.

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