Wall Street’s volatility was evident last week. Stocks fell after Jerome Powell (Federal Reserve chair) vetoed the market’s hopes of a pivot, and suggested that there are more rate hikes. Wall Street continues to look to Washington for its future.
Investors are betting heavily on a huge Republican wave during the midterm elections. If Republicans win at most one chamber of Congress in Tuesday’s midterm election it will likely lead to more gridlock which is what the market typically loves.
Edelman Financial Engines data indicates that the S&P 500’s annualized return was 16.9% for the nine years since 1948 when a Democrat was elected to the White House and Republicans held a majority in both Congress chambers. This compares to 15.1% for periods of Democratic total control and 15.9% for years with a unified GOP government.
Investors love it when politicians disagree but don’t pass any new laws that might hurt corporate profits.
You can forget about taxes
One example: taxes on businesses
“What do the midterms mean to the markets?” Aptus Capital Advisors portfolio manager David Wagner stated that if Republicans take the House, tax increases will cease to be possible. Republicans may not approve of a windfall tax on oil company profits but they are generally against tax increases for the wealthy.
The market also believes that specific sectors will see a boost even if Republicans gain control of the Senate and House, which would make it more difficult to pass laws for President Biden.
Because there are certain areas of agreement between the White House and Republican legislators.
Wagner said that a GOP sweep could mean more defense spending. “Increasing the defense budget seems to be a bipartisan matter.” The House approved a record-setting high defense budget proposal in July.
Biden and Republicans appear to be on the same page about infrastructure spending. This could help utilities, construction firms, and some real estate stock. Last year, Congress passed a $1 trillion multi-party infrastructure bill that was supported by President Biden. However, it is not clear what the demand is for more spending… even if there is agreement that more is necessary.
“Everything has become polarized politically. But there is common ground regarding infrastructure. Jim Lydotes is the deputy chief investment officer of equity at Newton Investment Management. “As an entire country, we have under-invested in infrastructure. There is much agreement in this area.
Gridlock isn’t always a good idea
It is not certain that Biden and other Democratic leaders in Congress will be able to work well with Republicans. Once the midterms are over, the political narrative is likely to shift to the 2024 Presidential race. Congress and the White House might spend more time bickering over trying to pass legislation.
However, there could be significant downsides to a divided government. This is especially true if the fears of a future recession become reality.
Rob Dent (US senior economist at Nomura Security International) said that there would be less federal spending on the social safety net programs if Republicans took control of Congress.
Dent said, “All other things being equal,” that this could lead to a longer recovery from the recession. Stocks would suffer more as a result, since corporate profits are driven primarily by consumer spending.
Dent also said that Washington could be getting rowdier about the debt ceiling. That was the last time it was a major issue during President Barack Obama’s first term. As a result, the US was stripped of its AAA credit rating by Standard & Poors. After August 2011, the downgrade of the US debt ceiling drama, the stock market plunged over 5%.
Dent said that this election result is less about what might happen than what might get done to improve the economy in a downturn. “We are worried about a divided government leading to brinkmanship around the debt limit, and the potential for government shutdowns. This has not been an issue for us in a long time.”
At the end of it all, however, political headlines can be just noise for markets. Anthony Saglimbeni was the chief market strategist for Ameriprise. He stated that stocks have always gone up after elections, regardless of who controls Congress or the White House.
Other macro issues may take the midterms out of focus. Saglimbeni pointed out that long-term investors will be more interested in “growth, profits, and inflation” than “interest rates, interest rates, and profit growth.” Although he conceded that elections could cause more volatility in the short term, the market has already priced in a high likelihood of a divided government.
A political-induced market and economic instability are not what consumers, investors, or the Fed requires. This is because inflation has proven to be temporary as Fed chair Powell predicted it would be for much of 2021.
There will be an increase in commodity prices, raw materials, transportation costs, and labor costs.
Steve Cahillane, CEO of Kellogg (K), a snack and cereal food giant, said last week on the company’s latest earnings call that the notion that “inflation would be transitory” was absurd.
On Thursday, the government will report the September consumer price Index (CPI) numbers. This will give us a better understanding of the persistence of inflation.
Reuters polled economists and found that they expect overall prices to rise 0.7% this month. This is up from a 0.4% increase in September. This would likely drive year-over-year inflation, which has risen 8.2% in 12 months from September, higher. Price pressure will increase due to the strength of the employment market.
Troy Gayeski is the chief investment strategist for FS Investments. He stated, “The labor market remains resilient and inflation has spread to the services sector too.”
It could lead to greater concerns about the economy heading for a so-called “stagflation” environment. This is a situation where stagnant growth and high inflation coexist. If this happens, the Fed is likely not to lower rates for much longer.
“We will exit this inflationary/stagflationary situation eventually,” Gayeski said. “But it’s unlikely that the Fed will cut rates quickly to zero. It will be extremely cautious.”