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Last week was a volatile week on Wall Street, with stocks falling after Federal Reserve Chairman Jerome Powell dashed the market’s dream of a pivot, suggesting another big rate hike is likely. Did. But Wall Street still has its hopes in Washington.
Investors are betting on a big Republican wave in the midterm elections. If Republicans win at least one House of Congress in Tuesday’s midterm elections, it’s likely to be more of a stalemate than the market usually likes.
Data from Edelman Financial Engines show that the S&P 500’s annualized return has been in the nine years since 1948, when Democrats were in the White House and Republicans controlled both houses of Congress. This compares to 15.1% when the Democratic Party was in full control and 15.9% when there was a United Republican government.
Investors rejoice when politicians bicker, but they don’t actually enact new laws that can hurt corporate profits.
One example is corporate taxes.
“What will the midterm elections mean for the markets? If Republicans win the House, tax increases will sink into the water,” said David Wagner, portfolio manager at Aptus Capital Advisors. Republicans are less likely to approve a windfall tax on oil company profits and are generally not in favor of higher taxes on the wealthy.
The market is also betting that some sectors could get a boost even if Republicans control the House or Senate, possibly making it more difficult for President Biden to pass legislation.
That’s partly because there’s a consensus between the White House and Republican lawmakers.
“A Republican sweep could lead to an increase in defense spending,” Wagner said. “Increasing the defense budget seems to be a bipartisan issue.” The House passed the largest defense budget in history this summer.
Biden and Republicans also appear to be on the same page when it comes to spending more on infrastructure, which could boost utilities, construction companies and some real estate stocks. Congress passed a bipartisan infrastructure bill worth more than $1 trillion last year, with President Biden backing it. But even if there is a consensus that more spending is needed, it is not yet clear what the desire for more spending is.
“Everything is politically polarized, but there is a common ground in infrastructure. [Donald] with playing cards [Hillary] Jim Lidortz, Deputy Chief Investment Officer, Equities, Newton Investment Management, said: “As a country, we are not investing enough in infrastructure. It is an area where there is a lot of agreement.”
Of course, there is no guarantee that Biden or any other Democratic leader will be able to work effectively with Republicans in Congress. After all, with the midterm elections in the rearview mirror, the political narrative will quickly shift to his 2024 presidential campaign. Congress and the White House may spend more time arguing than trying to pass legislation.
Also, a divided government may have some serious drawbacks. Especially if fears of a recession come true next year.
Rob Dent, senior U.S. economist at Nomura Securities International, said a Republican takeover of Congress could cut federal spending on social safety net programs.
“All else being equal, the recovery from the recession could be longer,” Dent said. This is generally bad for stocks, as consumer spending drives corporate profits.
Dent added that there could be more debate in Washington about the debt ceiling.The last time it became a major issue was during President Barack Obama’s first term. As a result of the drama, it lost its valuable full AAA credit rating from Standard & Poor’s. After the downgrade occurred in August 2011, the stock market plunged more than 5% of him.
“This election result is more important than what we can or cannot do to help the economy during a recession,” Dent said. “We worry that a split government will lead to a brink about debt ceilings and possible government shutdowns. We haven’t had to deal with that for quite some time.”
But at the end of the day, political headlines are often just market noise. Anthony Saglimbane, chief market strategist at Ameriprise, said on a conference call about the midterm elections last week that historically stocks have risen after elections, no matter which party controls the White House and Congress.
The midterm elections could also be “backwards” to other macro issues. Saglimbene noted that “growth, earnings, inflation and interest rates” are more important to investors in the long run. He acknowledged that the election results could increase short-term volatility, but acknowledged that the market had already priced in a likely government split.
Given that inflation has turned out to be more than temporary, as Fed Chairman Powell predicted for much of 2021, politically-induced market and economic volatility is likely , or the last thing the Fed needs.
It is clear that the rising cost of goods and other raw materials, transportation and other transportation costs, and labor costs will not go away anytime soon.
“The idea that inflation is going to be temporary is always plainly absurd,” said Steve Cahirane, CEO of cereal and snack giant Kelloggs (K), on the company’s latest earnings call last week. ‘ he even said.
We will have a better idea of how persistent inflation is on Thursday after the government releases its September consumer price index (CPI) figures.
Economists polled by Reuters expect overall prices to rise 0.7% last month, up from a 0.4% rise in September. This could also push the year-over-year price higher, which saw him up 8.2% in the last 12 months through September. Continued strength in the job market will also put further pressure on prices.
“The labor market is resilient and inflation is spreading to the services sector,” said Troy Gajeski, chief investment strategist at FS Investments.
This could raise concerns that the economy is heading towards a so-called stagflation environment. If that happens, the Fed may hold interest rates longer.
“Ultimately, we’re going to get out of this inflation/stagflation situation,” said Geyski. “But the Fed is not going to cut interest rates to zero anytime soon.
Monday: China trade data; earnings from BioNTech (BNTX), Take-Two (TTWO), Ryanair (RYAAY), Lyft (LYFT)
Tuesday: U.S. midterm elections; DuPont (DD), Norwegian Cruise Line (NCLH), Lordstown Motors, Disney (DIS), Occidental Petroleum (OXY), News Corp (NWS), IAC (IAC), AMC (AMC), Novavax Earnings from (NVAX)
Wednesday: Chinese inflation data. Revenue from DR Horton (DHI), Weibo (WB), Hanesbrands (HBI), Capri Holdings (CPRI), Roblox, SeaWorld (SEAS), Wendy’s (WEN), Redfin (RDFN), Beyond Meat (BYND)
Thursday: US CPI; US weekly unemployment claims; Revenue from Nio (NIO), Ralph Lauren (RL), Tapestry (TPR), WeWork, Six Flags (SIX), Yeti (YETI), Warby Parker
Friday: US bond markets are closed for Veterans Day. UK GDP; Michigan US consumer sentiment; Revenue from SoftBank (SFTBF)
