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The past week has been volatile on Wall Street, with stocks falling after Federal Reserve Chairman Jerome Powell dashed market pivot dreams and suggested that more big rate hikes are likely. But Wall Street still turns its hopes on Washington.
Investors are betting on a big Republican wave in the midterm elections. If Republicans take at least one chamber of Congress in Tuesday’s midterm elections, it will likely lead to more gridlock, which the market generally likes.
According to data from Edelman Financial Engines, the S&P 500 has had an annualized return of 16.9% since 1948 during the nine years that a Democrat was in the White House and Republicans had a majority in both houses of Congress. That compares to 15.1% during periods of full Democratic control and 15.9% in years when there was a unified GOP government.
Investors are more than happy when politicians bicker but fail to enact new laws that could hurt corporate profits.
An example is the business tax.
“What do the mid-terms mean for the markets? If the Republicans get the House, the tax hikes are dead in the water,” said David Wagner, portfolio manager at Aptus Capital Advisors. Republicans may be less inclined to endorse a windfall tax on oil company profits and generally do not favor tax hikes on the wealthy.
The market is also betting that certain sectors could get a boost — even if Republicans take control of the House or Senate and presumably make it harder for President Biden to pass legislation.
That’s because there are areas of consensus for the White House and Republican lawmakers.
“A GOP sweep could lead to more defense spending,” Wagner said. “Increasing the defense budget seems to be a bipartisan issue.” The House passed a record defense budget this summer.
Biden and the Republicans also seem to be on the same page when it comes to increasing infrastructure spending. This could give a boost to utilities, construction companies and some real estate values. Congress passed a bipartisan $1 trillion-plus infrastructure bill last year, which was championed by President Biden after all. But it’s not clear yet what the appetite for more spending is…although there is consensus that more is needed.
“Everything is polarized politically, but there was common ground on infrastructure. This was even the case with [Donald] Trump and [Hillary] Clinton in 2016,” said Jim Lydotes, deputy director of equity investments at Newton Investment Management. “As a country, we have underinvested in infrastructure. This is an area where there is a lot of agreement.
Of course, there’s no guarantee that Biden and other Democratic leaders will be able to work effectively with Republicans in Congress. After all, the political narrative will quickly shift to the 2024 presidential race once the midterms are in the rearview mirror. Congress and the White House could spend more time bickering than trying to pass legislation.
There can also be significant downsides to a divided government, especially if fears of a recession materialize next year.
Rob Dent, senior U.S. economist at Nomura Securities International, said the federal government could spend less on social safety net programs if Republicans take control of Congress.
“All things being equal, this could lead to a longer recovery from a recession,” Dent said. This would be bad for equities more generally as consumer spending boosts corporate earnings.
Dent added that there was also the unfortunate possibility of further wrangling in Washington over the debt ceiling. The last time this was a major issue was during President Barack Obama’s first term. The United States lost its precious AAA credit rating from Standard & Poor’s following the debt ceiling drama. The stock market plunged more than 5% after the August 2011 downgrade.
“This election result is less about what could be done than what might not be done to help the economy in a downturn,” Dent said. “We fear that the divided government will lead to a precarious situation on the debt ceiling and the potential for government shutdowns. We haven’t had to deal with this for quite some time.
But in the end, political headlines are often just noise to the markets. Ameriprise chief market strategist Anthony Saglimbene said on a conference call last week about midterms that stocks have historically risen after the election regardless of which party controls the White House. and Congress.
Midterm reviews can also take a back seat to other macroeconomic issues. Saglimbene noted that “growth, earnings, inflation and interest rates” matter more to long-term investors. He conceded that the election results could lead to more short-term volatility, but the market is already pricing in a high probability of a divided government.
Policy-induced market and economic volatility is the last thing consumers, investors or the Fed need given that inflation has proven not to be transitory as the President of the Powell Fed for much of 2021.
It is clear that higher prices for commodities and other raw materials, shipping and other transportation costs and labor costs are not going away any time soon.
Steve Cahillane, CEO of cereal and snacks giant Kellogg (K), even said on the company’s latest earnings call last week that the idea that “inflation was going to be transitory was still obviously ridiculous.”
We will have a better idea of the persistence of inflation on Thursday after the government releases the Consumer Price Index (CPI) figures for September.
Economists polled by Reuters forecast that overall prices rose 0.7% last month, from 0.4% in September. That would likely push year-over-year prices, which rose 8.2% in the past 12 months to September, even higher as well. The continued strength of the labor market will also put increased pressure on prices.
“The labor market is resilient and inflation is also spreading to the services sector,” said Troy Gayeski, chief investment strategist at FS Investments.
This may raise fears that the economy is heading towards an environment known as stagflation, a period where stagnant growth occurs alongside high inflation. If that happens, the Fed should keep rates higher for longer.
“We will eventually get out of this inflationary/stagflationary situation,” Gayeski said. “But it’s not like the Fed is going to cut rates to zero anytime soon. He will be very careful.
Monday: China trade data; revenues from BioNTech (BNTX), Take-Two (TTWO), Ryanair (RYAAY) and Lyft (LYFT)
Tuesday: US midterm elections; revenues from DuPont (DD), Norwegian Cruise Line (NCLH), Lordstown Motors, Disney (DIS), Occidental Petroleum (OXY), News Corp (NWS), IAC (IAC), AMC (AMC) and Novavax (NVAX)
Wednesday: data on inflation in China; revenue from DR Horton (DHI), Weibo (WB), Hanesbrands (HBI), Capri Holdings (CPRI), Roblox, SeaWorld (SEAS), Wendy’s (WEN), Redfin (RDFN), and Beyond Meat (BYND)
Thursday: US CPI; weekly jobless claims in the United States; revenue from Nio (NIO), Ralph Lauren (RL), Tapestry (TPR), WeWork, Six Flags (SIX), Yeti (YETI) and Warby Parker
Friday: The US bond market is closed for Veterans Day; UK GDP; consumer sentiment in the U. from Michigan to the United States; SoftBank (SFTBF) revenue