Markets Love Gridlock From Midterms, But Risks And Opportunities Still Lurk

It takes two days to settle a trade in 2022. It takes two weeks (or more) to resolve an election. As the country and markets await mid-term top results, it is not too early to look to the world of “hidden” policy next year for potential legal effects on the bottom line.

Midterms Postmortem: 2022 Was an Election of Discontent

America is experiencing the lingering effects of a once-in-a-century pandemic, with fears of a contracting economy, labor unrest, and rising political extremism, fueling inflation. The voters wanted a “return to normalcy”. For this it was not only 2022, or 2020. The year was 1920. Then-senator Warren Harding (R-Ohio) ran a presidential campaign on the promise of “normalcy” and “restoration” after a world war, the Spanish flu, inflation, recession, labor unrest, and the revival of the Ku Klux Klan.

This return to normalcy has become a common theme in American elections. Voters are “thermostatic” in nature – if they perceive extreme left or right, they turn up at the polls. A century after the 1920 elections and voters are again facing the demand for normalcy.

What anomalies have come up against President Joe Biden and the Democrats in control of Congress? Economically, there was the highest inflation in 40 years, the lowest levels in consumer confidence in 40 years, and a sharp drop in disposable real income. It’s no wonder why most Americans think the country is in a recession, even though the job market is still strong.

The pandemic is no longer top of mind for most voters, but it is less a declaration of victory and more an ongoing disease of its unhealthy consequences. Some crimes are on the rise, drug overdoses continue to be at crisis levels, and students’ math and reading scores have plummeted. The perennial issue of immigration also remains a powerful force, with the US-Mexico border crossings at an all-time high.

But the 2022 anomalies didn’t just go against the Democrats. The conservative Supreme Court has struck down the abortion bill for almost 50 years Roe v. Wade earlier this year, with several Republican-led states further restricting or banning abortions.

The 2020 presidential election remained front and center in the Republican Party. President Donald Trump’s staying power has included investigations into the January 6 riots and other Trump-related investigations for voters. His opinion in the Republican primary has elevated candidates with little governing experience.

Finally, Democratic anomalies were higher than Republican ones. Inflation was the top issue for voters, and Republicans are on track to win the national popular vote by several points. However, these partisan differences in anomalies were much smaller than expected. Democrats won critical independent votes, are in a good position to take the Senate, and will see their smallest losses in House seats since 2002 (although they may still lose the House majority).

Americans are returning to normalcy but they have a conflicting narrative about which side is best to bring about that return and how. This leaves an unclear mandate for lawmakers moving forward.

A mixed election leaves Monetary Policy as the Market’s Headline

Even before the turbulent midterms, the market focused less on the machinations of Congress and the White House and more on what was going to happen at the Federal Reserve. Monetary policy is the main focus of Washington, DC, and markets are looking to see if fiscal policy will help or hinder the Fed’s job of suppressing inflation.

So the big market move this week wasn’t from the election, but a softer Consumer Price Index that reads hoping (or delusional) the Federal Reserve will soon ease its historic tightening.

The supporting role that fiscal policy plays can help. As the saying goes, “Wall Street loves gridlock.” There is some truth to it. The S&P 500 has historically outperformed in divided government. Since 1950, there has not been a single negative market return in the 12 months following a midterm election. The theory goes that post-election creates more certainty and divided government means fewer laws can be passed. This reduces policy risks and thus creates less volatility for the markets. A divided government next year will not pass a progressive spending agenda that reverses the downward trajectory of deficits and forces the Fed to raise rates further.

In fact, next year’s 118th Congress is not where political leaders will receive their legislative legacies. If Republicans win back the House, this is where they plant the policy seeds with messaging bills on things like blocking IRS funding, fighting against ESG investing, and increasing fossil fuel production. Political parties are more cohesive and ideological, so a Republican conference with a narrow majority is likely to pass these bills in the House. Of course, these bills will not pass the Senate, where a 60-vote majority is needed to pass. But the seeds planted next year become the laws and regulations of 2025 if Republicans control the White House and Congress.

There’s a Merger Between the Distributions That Can Still Impact Marketing

The partisan secret of Washington, DC is that most of the major legislation passed each year is done on a bipartisan basis. Things that get done in a divided government may not make the headlines.

That’s what Simon Bazelon and Matthew Yglesias created “Secret Congress”. There are some issues that don’t fuel partisan hatred, allowing progress to happen under the radar. Even some high-profile bipartisan efforts at political marriage are short-lived. Fewer than a quarter of voters know that Congress passed the $1.2 trillion Infrastructure Investment and Jobs Act last year. The bipartisan legislation includes some of the largest investments ever in areas such as public transportation, bridge construction, and broadband deployment.

Today, there are many political issues that fly under the radar and cannot be divided along traditional Republican and Democratic lines. All can have meaningful implications for various industries.

Both parties are increasingly hostile to China, with bipartisan support for exploring foreign investment in foreign countries and strengthening ties with Taiwan. Republicans and Democrats continue to tout crypto policy as a bipartisan partnership worth advancing, especially in the wake of the FTX debacle. Allowing the reform is in the interest of both parties as a way to accelerate domestic energy production. The data privacy legislation has bipartisan support that will continue to push for action in the next Congress. The telehealth industry has seen broad congressional support for its adoption and expansion into the healthcare space.

Of course, there is always tax policy. In addition to major partisan battles over rates, the tax lobby creates bipartisan alliances for some industries. Especially with the potential economic slowdown, bipartisan calls will only increase to provide tax relief for housing, corporate R&D, and gig economy workers.

While all of these bipartisan efforts are not guaranteed to pass into law, the legislative wheels are set in motion, regardless of what the midterm results look like.


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