Stocks: What To Expect From U.S. Midterm Elections

Next month’s midterm election battle for control of the U.S. Senate is going to be a dramatically close call. Republicans can gain control of the Senate if they win six new seats. Incumbent Democrats are defending 21 seats, and seven of those are in broadly red states won by Mitt Romney in 2012. Conventional wisdom would suggest that President Obama’s low current approval ratings would provide a significant tailwind for the GOP, but the reality is a little more complex. First and foremost, the broad approval ratings of the legislative branch (both parties) are even lower than those for the president as the electorate is generally disappointed in Washington’s performance. Secondly, the state-by-state situations are complicated and unique. We have some disruptive third party candidates in several elections; we have seen some candidates’ prospects diverging from their local party strength/weakness based on their own campaigning skill or lack thereof. Third, several national issues that were GOP rallying points in prior months have lost some of their punch. In particular, public concern about the ACA (Obamacare) has fallen significantly. Similarly, the GOP effort to run on support for U.S. energy independence and energy-based job creation seems less effective with dramatically falling oil/gasoline prices. Finally, despite the oft-cited portrayal of the GOP as the party of Big Money, the Democrats have a significant overall funding advantage in these elections; that money will give them an edge in the advertising barrage that we will see down the home stretch.

Currently, odds-maker and strategist consensus suggests a slightly better than average chance that the GOP seizes control of the Senate. We see things similarly. But if we dig a little deeper, what might the potential different outcomes mean more specifically for specific industries? Some notable examples of areas that would likely be affected are:

Energy: A GOP win would significantly change the tone around energy policy discussion. A GOP win would likely result in Mitch McConnell (R-KY), a staunch defender of coal, becoming Senate Majority Leader, Lisa Murkowski (R-AK), a vocal supporter of legalizing oil exports, heading the Senate Energy Committee and Jim Inofe (R-OK), famous for calling global warming “the second biggest hoax ever” stepping in as chair of the Senate Committee of the Environment and Public Works. Prospects for LNG and crude oil exports, accelerated drilling licenses offshore and on federal land, and reduced regulation or threats to MLP’s would clearly improve. Conversely, subsidies for alternative energy would come under greater scrutiny.

Healthcare: While much of the rhetoric around a GOP resurgence six months ago swirled around pledges to reverse the ACA, any serious effort along those lines seems highly unlikely at this point. Even issues such as rescinding the medical device tax would be tough to reconcile with a broader push to balance budgets given the need for a very hefty offsetting budget item. Some efforts to slow or reverse portions of ACA reimbursements are more likely, potentially causing stress on some struggling hospitals. The backdrop of scrutiny on specific pharmaceutical and biotech pricing would likely improve with a GOP win.

Defense: While the initial assumption might logically be that a GOP win would create a more friendly environment for defense spending, we would offer a note of caution. That’s because a GOP win would likely result in John McCain becoming the chair of the Senate Armed Services Committee. Sen. McCain is a passionate supporter of the military, but has often been a vocal critic of expensive new weapons systems.

There are many other niches that may be significantly affected. Lower regulation (good for many financials and for-profit education) and lower discretionary government spending (bad for domestic infrastructure build) would likely follow a GOP win.

Regardless of the midterm outcome, the bigger game for both parties is positioning for the 2016 elections. One of the major issues for both parties to address between now and then is their stance on tax reform. Many observers believe that no room for compromise around tax and entitlement reform is likely before the presidential election. However, I do believe that the groundwork for discussion will begin to form and increasingly be a market focus. We noted a few weeks ago that “[w]hile there is clearly a wide political divide on key elements of comprehensive tax reform, there does seem to be some common ground. Republicans want to lower tax rates, but may be open to closing loopholes. Democrats want to raise tax revenues while eliminating perceived inequities. This would seem to leave the closing of loopholes as common ground for compromise. Therefore, while comprehensive tax reform is unlikely to pass ahead of the 2016 elections, we suggest caution around companies that have taken particularly aggressive tax stances. Debate around these issues is likely to draw market attention to the risks to earnings in advance of legislation actually being passed.”

Let us end on an optimistic and bipartisan note. While there is no definitive reason why, the 12-month periods following midterms since 1950 have been very friendly for equity investors. The market has been up in all sixteen of these periods, with a 16.1% average return by the S&P 500 Index (chart). Perhaps expectations drop on fears of change and disruption, and the reality surprises on the upside. We hope that this year’s hard-fought election bodes well for markets yet again regardless of who prevails.

Source: Columbia Management Investment Advisers, LLC. Past performance does not guarantee future results. It is not possible to invest directly in an index.