As of Nov. 14, 2022
The midterm elections may be over, but uncertainty lingers as key races for the U.S. House of Representatives have yet to be called. With this context in mind, here’s our view on the potential market impacts of the 2022 U.S. election results and key dynamics for investors to consider.
A divided government is likely
As of Nov. 14, Republicans look poised to win control of the House of Representatives, while the U.S. Senate will remain in the hands of Democrats. Investors expected an election result that would divide Congress over the next two years. In our opinion, such a result will likely be welcomed by investors over time who have dealt with an exceptional level of volatility and uncertainty this year as stock and bond prices have fallen. Combined with better seasonality factors, a divided government could play a role in helping improve very weak investor sentiment.
Performance begins the first month a president enters office to the last month they are in office. Data as of 09/30/2022, beginning in 1928.
Data source: Bloomberg, S&P Dow Jones Indices. Past performance is not a guarantee of future results.
4 ways a split Congress may impact investors
Below are a few high-level points to consider regarding a divided U.S. Congress:
- Gridlock is likely the main thrust of the legislative agenda over the next two years. As a result, tax changes and fiscal spending will likely be limited. Net-net, divided government in Washington is a positive for stocks, in our view.
- A debt ceiling standoff could lead to stock volatility. A divided Congress will still need to raise the debt ceiling sometime in mid to late 2023 and address a new federal budget. A split government could put more pressure on politicians to use the debt ceiling/budget to debate fiscal policies and stand firm on hardline stances over the role of government. This could increase market volatility should Congress fall into a more prolonged debt ceiling standoff, risk a government credit downgrade (similar to 2011), and risk a government shutdown if a budget agreement can not be found. However, our base case is that politicians will not want to play a game of chicken with the creditworthiness of the United States, risk a default, or leave the government shut down for an extended period of time.
- Markets are on their own and likely beholden to the Fed: If a recession forms next year or there is a more prolonged slowdown, it is unlikely a divided government will be able to provide meaningful fiscal relief. Moreover, given the current state of inflation, Democrats and Republicans are unlikely to open the purse strings as they did in the 2008-2009 downturn or during COVID-19.
- Democrats and Republicans may be able to find common ground on a Farm Bill, boosting U.S. industrial competitiveness, promoting near-shoring initiatives, and forming some give and take on extending the child tax credit in exchange for other business-friendly tax credits (such as for research and development).
Remember: Elections only impact the markets so much
Fortunately, stocks tend to power through elections over time, with the S&P 500 Index posting a longer-term average return of roughly +9.0%, regardless of the makeup of the government. And while other government compositions outside of divided government can produce returns that are better or worse than the average, the sample sizes tend to be small, and there are always other more pressing factors that tend to drive stocks in any one direction.
A post-election rally may give way to external factors
The S&P 500 historically sees improved near-term performance in the months following the mid-term election versus the months before the election, no matter the result. That’s because markets respond better to certainty than uncertainty, as investors can undoubtedly sympathize with this year. And while stocks may breathe a sigh of relief from a result that creates a divided government, growing global recession concerns, high inflation, and tighter central bank policies could limit the enthusiasm seen in a post-election rally if one were to occur. In our view, investors should discount the composition of the next Congress to some extent and focus on what's likely to drive stocks through next year.
Sources: Bloomberg, S&P Dow Jones Indices. Data as of 12/31/2021 based on calendar months beginning in 1945. Since we do not have pre- and post-2022 elections data, this data includes midterms up through 2018. Past performance is not a guarantee of future results.
Now that the midterms are over, what dynamics will investors watch for?
Investors will likely shift their attention to Fed policy, inflation, and jobs:
Themes from the Q3 earnings season
With the third quarter earnings season nearly complete, the S&P 500 blended earnings per share (EPS) growth rate stands at +2.2% year-over-year on sales growth of +10.7%. During Q3 earnings calls, a wide range of S&P 500 companies pointed to a cautious outlook and a high degree of macroeconomic uncertainty. In aggregate, S&P 500 companies highlighted ongoing inflation pressures and supply chain constraints, though issues on the supply side appear to be improving. A shift to goods for services remained a big theme across earnings calls, with a weaker housing market adding to lower spending on big-ticket items. In addition, margin pressures are a growing threat, with elevated inventories and some price cutting squeezing profits. We expect these themes to continue through the fourth quarter.
Fed policy & inflation
Rising interest rates have been front and center for investors all year. Earlier this month, the Federal Reserve raised its fed funds target rate by 75 basis points, the fourth such jumbo rate hike in as many meetings. The rate increase now brings the fed funds target rate to 3.75% - 4.00% — a level last seen when the target rate was falling in 2008 amid the Financial Crisis. Notably, variable-rate debt and new mortgages will again become more expensive. But the yields earned on savings accounts, CDs, and money markets are likely to rise with time, though at a slower pace.
For markets, the Fed has expressed a desire to maintain maximum flexibility on addressing high inflation, which will likely keep the central bank pressing rates higher as long as inflation remains elevated. Unfortunately, investors should expect stocks to face continued headwinds until the Fed signals it is near the end of its rate-hiking campaign.
While a host of economic, earnings, and sentiment data suggest growth is slowing in the U.S., job growth remains incredibly resilient, keeping the Fed's well-entrenched narrative of raising interest rates higher and leaving rates higher for longer in place. And given labor trends are a lagging indicator, investors will need to anticipate how much damage to growth ultimately occurs from a higher terminal rate and before labor conditions slow enough to give the Fed pause. This is the market's current conundrum regarding jobs— reinforcing the idea that a labor market that is too resilient could eventually lead to a more disruptive decline down the road should the Fed overtighten monetary policy.
Your financial advisor is here to help you weather uncertainty
Your portfolio should be built to weather different market and political environments. If you feel uncertain about the current market environment, reach out to your Ameriprise financial advisor. They can address any concerns you may have.
Data sources for indices and sector graphs: Morningstar Direct, as of Nov. 4, 2022
Past performance is not a guarantee of future results.