The fact that the midterm election will soon be over may be enough to spark a rally for stocks, but investors may also cheer the prospect of Washington gridlock as the best outcome for the market. Republicans look set to win back the House of Representatives in Tuesday’s elections. The outcome in the Senate could also be a Republican majority, but that relies on a number of very close races. Either way, there will likely be no consensus between Congress and the White House. The potential results of gridlock “I think there will be things about gridlock the market likes. There will be things about gridlock the market doesn’t like,” said Ed Mills, Washington policy analyst at Raymond James. “As a whole, the most important outcome is getting it in the rear-view mirror so we know what we’re dealing with.” Democrats currently control the White House and both houses of Congress. In the Senate, the two parties each have 50 seats, but Vice President Kamala Harris can cast a tie-breaking vote. What the market would like about a Republican-controlled Congress is potentially less spending by the Biden Administration on a new infrastructure plan and any taxes associated with it. But the market will not like a battle over the debt ceiling that could emerge next year if Democrats don’t try to resolve it in the lame-duck session later this year. “The biggest negative for the market is headline risk, and the biggest headline risk is the debt ceiling,” said Tom Block, Washington policy analyst at Fundstrat Global Advisors. “Raising the debt ceiling just allows the Treasury to pay the bills that have been accrued. We all know that at the end of the day we’re going to pay our bills.” The debt ceiling caps the amount of money the government can borrow, and it has been raised dozens of times, sometimes after a big fight. “If you are a Republican, you are scared to death of the debt ceiling… you know if you vote to increase the debt ceiling, it is going to be used against you,” Block said. With respect to market sectors, strategists say that the traditional domestic energy sector may get a boost if the Republicans are in control of Congress. Further, health-care companies could benefit from GOP opposition to price controls. Meanwhile, defense and cybersecurity may benefit from more spending under Republicans. On Monday, clean energy names were hit while oil and gas shares rose. The iShares Global Clean Energy ETF slipped about 1%, and the Invesco Solar ETF was down 1.3%. The Energy Select Sector SPDR Fund, which tracks the oil and gas names in the S & P energy sector, was up 1.7%. Historically, stocks rise after midterms Mills of Raymond James said the market in general should get some relief from the sheer fact that the election is over. From Nov. 1 in a midterm election year to the following November, the S & P 500 has always been higher. But according to CFRA Research, in those November-to-November years when the presidential party lost the majority in one or both houses, the gains were smaller. In general, history shows that the best returns on average have been when a Democratic president faced a divided Congress. The returns in those years averaged 13.6%, but they dropped to 13% when both the House and Senate were controlled by Republicans. CFRA’s data shows when Democrats controlled Congress under a Democratic president, stocks averaged a 9.1% gain. Meanwhile, under a Republican president, the stock market on average gains 4.9% when Democrats control Congress, and the market gains 7.3% with a split Congress. Finally, when there would be a Republican in the White House, and the party also controlled the House and Senate, the S & P 500 averaged a 12.9% gain. “The market might actually like a Republican-controlled Congress because there’s a likelihood that whatever the Republican House pushes through the Senate might sign off on,” said Sam Stovall, chief investment strategist at CFRA. But strategists also note that the Republicans may not get too far pushing through their agenda because President Joe Biden will still have the power to veto. GOP win in 2022 and beyond? Strategas Research says the stock market is signaling that Republicans may sweep the election . The firm constructed portfolios that should do better or worse depending which party has control. Its Republican portfolio, which contains stocks from sectors like energy, as well as police and immigration enforcement firms, has outperformed and was signaling 75% odds of a GOP sweep as of Monday’s close. But more importantly, Strategas says the size of the potential Republican win in the House could set the stage for the next election, and keep the GOP in control there through the next election. Dan Clifton, head of policy research at Strategas, estimates the Republicans could gain 27 seats, bringing the total to a historically high 240 seats. He said the Republican portfolio he constructed has risen on gains in energy infrastructure and biotech shares. “The Republican gain in the House could be so large that it takes a Democratic sweep off the table in 2024, and the market can kind of see that,” he said. “Drug pricing is not going to get worse and financial regulation is not going to get worse.” Piper Sandler strategists agree. “A big GOP night could make a Democratic sweep in 2024 a long shot, which could kill Medicare for All/the public option or any legislation putting a price on carbon for the foreseeable future,” writes Andy Laperriere, Piper Sandler’s head of U.S. policy research. Some of the companies in the Strategas Republican portfolio are Axon Enterprise, Johnson & Johnson , The Williams Cos , Huntington Ingalls Industries , ConocoPhillips and OSI Systems . Strategas also notes that gridlock would result in less spending, and therefore a less inflationary environment. So iShares 1-3 Year Treasury ETF (SHY) is in its Republican portfolio. Yields move opposite prices, so bond yields should fall in a less inflationary environment. Close Senate races Political strategists say the Senate is too close to call, but it appears to be leaning toward Republicans. “From a statistical standpoint, it’s really close but that doesn’t mean the results will be close,” said Mills. Mills said even if Democrats hold the Senate, the Republican-controlled house would be busy with its own agenda. “I think highest on the list is a continued ‘get tough’ on China approach,” he said. Both parties may find common ground on that topic, and the sector most affected would be technology. Mills said U.S. National Security Advisor Jake Sullivan has discussed expanding protections for U.S. biotechnology and clean energy technologies. The Biden administration last month imposed export restrictions on semiconductors manufactured in China by U.S. companies. There are clear stock market winners from a Republican victory, at least in the House. “I think overall people would view it as positive for energy,” said Mills. He said chances would be improved for easier permitting for oil and gas production and a domestic energy agenda favored by Sen. Joe Manchin, a West Virginia Democrat who has sided with Republicans on some issues. That could benefit pipeline and energy services companies. Some companies may find the change in government more challenging. “Republicans going after ‘woke corporations’ is likely to be a major theme over the next few years,” said Laperriere. “If they have the majority, hearings targeting big tech, Wall Street (over ESG), and companies like Disney are likely. Much of this will be headline risk, though tech regulation could potentially win bipartisan backing.” “If Republicans win a majority in the House, Biden’s [Build Back Better] agenda, including any significant tax hike is dead in the water,” he said. Laperriere, in a note, wrote that tech, small cap and financial firms are most vulnerable to higher taxes and tougher regulations, and they could benefit from a Republican Congress. “If Republicans have both chambers, they are more likely to preserve expensing (rather than amortization) of R & D costs, extend full expensing of equipment, and perhaps prevent the limitation on net interest expense from tightening,” Laperriere added.
