Thoughts on the Midterm Election

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The midterm election takes place Tuesday, Nov. 6. There are local and state races to be determined, judges to be elected and referendums to be decided. The stock market, however, cares very little about any of that. What it cares about most are the Congressional elections and how they will dictate the balance of legislative power in Washington D.C.

Will the Democrats wrest majority control away from the GOP in the House and Senate? Will the GOP keep majority control in both houses? Will it be a split Congress?

Those questions will be answered soon enough, yet the conventional polling wisdom is presaging the likelihood of a split Congress with Democrats holding a majority in the House and Republicans maintaining majority control of the Senate.

Another way of casting such an outcome, should it come to fruition, is to say the midterm election will lead to political gridlock.

It wouldn't be the first time and it won't be the last. This time around, however, there seems to be a lot at stake with this election -- or is there?

Politics in the Mix

Political pundits on both sides of the aisle are in their element right now, making cases for why voters should vote for their party members. More often than not, the argument is cast in terms of how bad the incumbent has been as opposed to how good the challenger will be.

That's politics these days where campaigning is nasty business. In the end, though, the sausage always gets made and Americans duly elect their representatives.

So, how would a split Congress impact the stock market? The answer is that it already has.

Remember the October sell-off? It was precipitated by growth concerns that stemmed from a fear of rising interest rates, deepening trade tension between the U.S. and China, and clear signs of a slowdown in foreign economies.

We'll conjecture that there was another factor in the mix. That factor involved a growing belief that the midterm election would produce a split Congress.

Why would a split Congress be bad? It may not be, yet the read-through for this stock market is that a split Congress will stand in the way of passing additional fiscal stimulus and stifle additional efforts to reduce regulatory burdens.

Accordingly, we would attribute a portion of the October sell-off to a sense that the animal spirits which have been driving the stock market since the 2016 presidential election were going to be reined in by a divided Congress.

That doesn't mean they would be put back in the crypt altogether. It just means that the momentum of the fiscal and regulatory policies that has been building since the 2016 presidential election would be stopped in its tracks.

Besides, it will be extremely difficult to reverse policies given the president's veto power and the improbability of the Democrats having the 60 votes necessary in the Senate to override the president's veto.

What It All Means

When the results of the midterm election are known, they will be known and life will go on.

If conventional wisdom plays out and the Democrats take control of the House and the Republicans maintain control of the Senate, it won't be a surprise. The specter of that outcome was priced into the market as part of the October sell-off, which saw the S&P 500 drop as much as 10.7 percent.

If anything, an election result showing a split Congress might prove to be a relief, because the uncertainty surrounding the outcome will have been erased.

Furthermore, while some might think a split Congress could be construed as a negative outcome because nothing new will come to pass, except perhaps matters pertaining to national security or an infrastructure bill that the stock market would presumably be pleased to see, a split Congress is more likely a net positive at this juncture because it also implies things are likely to remain the same from a legislative standpoint.

The tax cuts will remain intact and a reduction in regulatory action will persist. The hurdle for the stock market isn't the election. The hurdles for the stock market are rising interest rates, the trade tension between the U.S. and China, and the slowdown in foreign economies, all of which are a headwind for earnings growth.

Those matters aren't going to be settled no matter what the composition of Congress looks like come Nov. 7.

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Chief Market Analyst