First take on midterm election results: Closer than expected, but gridlock still appears likely

Markets moved lower today, giving back some of the gains leading up to midterm elections and perhaps reflecting uncertainty around election results that have been closer than many expected. Overall, both the House and Senate look likely to have only minimal party majorities after results are finalized. The drop in equities also comes a day before the closely watched CPI (consumer price index) inflation report is set to be released. Here's our take on the initial election results and market implications.

1. What's happened in this year’s U.S. midterm elections so far?

After a record turnout in voting in this year’s 2022 midterm elections – with well over 60 million ballots cast and counted thus far – early results indicate a race much closer than many polls suggested earlier in the week. As of Wednesday morning, market betting odds suggested that Republicans will likely take control of the House, while Democrats may maintain a majority in the Senate, but several key races have yet to be decided. Nonetheless, even in this scenario, gridlock in Washington is likely, as there is less chance of new legislation or regulation passing in the final two years of this presidential term. If Democrats do maintain the Senate, the chance of new legislation is slim; however, they may be able to continue to approve nominations of federal judges and cabinet positions.

According to exit polling, key macroeconomic issues that drove voters this year included concerns around inflation and economic growth. All told, while the results are still coming in, it appears that when the dust settles, neither party will have a strong majority in the House or Senate. Political gridlock is likely, both between parties and within each party, but history has shown that stock markets may welcome this outcome.

2. How do markets perform around midterm elections? Gridlock can be good for investors

If history is any guide, market performance around midterm elections is fairly consistent. Since 1930, the average performance in the 12 months before midterms tends to be volatile and mixed, with the S&P 500 returning about 0.3%¹. This year's performance has been more volatile than a typical mid-term year compounded by a rapid rise in interest rates and geopolitical uncertainty.

However, in the 12 months after midterm elections, market returns are fairly strong. The S&P 500 is up on average about 16% during this time period¹. Keep in mind that this year the period after midterm elections may coincide with an eventual pause in the Fed rate-hiking cycle and perhaps some cooling in inflation trends as well, both of which would be supportive of markets.

Markets generally seem to welcome a gridlock outcome in midterms (a split White House and Congress by political party), what betting markets suggest we might ultimately see this year. In this scenario, there is little likelihood of passing new legislation or regulation, including new fiscal spending packages or tax reforms. This eliminates some volatility and also gives companies more clarity as they plan and budget for the year ahead. Although with no strong party majority in either the House or Senate, there may be increased uncertainty around certain events, like extending the U.S. government debt ceiling and fiscal budgeting, as both parties need to come together on an agreement. Perhaps the good news is that debt-ceiling debates over the years have been resolved, even with political gridlock, albeit often in the final hour.

3. Politics tend not to move portfolios over the long run

Despite headlines and near-term volatility, in our view, political events tend not to sway market performance over longer periods, regardless of which party is in power. Market returns instead are typically driven by the productivity and innovation of corporations, which lead to positive economic and earnings growth and market appreciation over time. Legislation and policies may set the ground rules by which companies can operate, but the outcome of any one election rarely shifts this backdrop meaningfully. Instead, investors should remain focused on their long-term financial strategy, and work with their financial advisors to create diversified portfolios that meet their goals and risk tolerances through all market and political cycles.

As markets head toward the end of the year, opportunities may be forming

As we look past midterm elections and toward the year ahead, we continue to see opportunities forming in both equity and bond markets. In our view, if inflation eases and the Federal Reserve heads towards a peak in its fed funds rate, this could spark a more sustainable recovery in markets in the months ahead. Investors can use near-term volatility to position their portfolios – to rebalance, diversify and ultimately add quality investments at better valuations.

Mona Mahajan
Investment Strategist

Sloane Marshall, CFA
Associate Analyst