Stocks Gain Ahead Of Midterm Results, But Where Are They Headed Next?

U.S. stocks opened modestly higher on Tuesday, as investors kept a watchful eye on the historically tense midterm elections. The stakes are high for American politics, and Wall Street will be carefully tracking the results and all possible shifts in the makeup of Congress.

Other news is making headlines—General Electric’s (NYSE:GE) CEO is buying shares, Tesla (NASDAQ:TSLA) is facing criticism about factory safety, and CVS’ (NYSE:CVS) earnings impressed—but the midterms are by far the largest story of the day.

Early voting has been open in many states for weeks, but with a number a races still far too close to call, Congress’ post-midterms look is still unknown. Recent opinion polls—and historical trends—suggest that the Democratic Party could gain a majority in the House of Representatives, while the Republican Party is likely to keep its control of the Senate.

That said, American voters have grown accustom to surprise victories in recent years, and there can be no certainties until the polls close and final counts start to roll in late Tuesday evening. This explains why some investors might be hesitant ahead of the results, as “uncertainty” is typically atop the list of Wall Street’s least-favorite words.

But the resolution of this uncertainty is just hours away, so prudent investors will be looking to get a sense of what is to come. Here’s what market strategists are saying right now.

Near-Term Bull & Bear Scenarios

Speaking in a recent episode of Zacks’ live daily web show, Free Lunch, Strategist David Borun outlined what he thought could be near-term bullish and bearish situations based on the results of the midterms:

In short, David thinks that a surprise Republican victory in the House, paired with the expected victory in the Senate, would be near-term bullish for stocks. This would give Republicans two more years in firm control of the federal government, allowing the party to continue rolling back certain regulations and cutting taxes as long as it pleases.

Previous tax cuts and deregulation initiatives have been received positively by Wall Street, even inspiring what some called the “Trump Trade” in the early days of the administration. These efforts cooled as the election cycle heated up, but a post-midterm Congress could get busy again.

On the other hand, a continued Republican grip on Congress might allow President Trump’s trade disputes to continue relatively unchecked. This could be bearish, as tit-for-tat tariffs between the U.S. and China have arguably become the stock market’s greatest headwind this year—although there is no guarantee that a different midterm result would create the coalition needed to roll back the White House’s power.

The above sentiment also implies that Democrats would actually want to stop the trade war, which might not be the case. As Deutsche Bank (DE:DBKGn) pointed out in a recent note, a Democratic win “could act as a check on the president’s trade war policies” but “some Democratic politicians have expressed support for President Trump’s trade war, so they may actually support an escalation against China.”

That said, the projected result of today’s voting—a Democratic majority in the House and Republican control of the Senate—could also be near-term bullish for Wall Street, according to David. Many have said that this would stall the aforementioned Republican agenda that investors seemingly liked, but David argues that federal government stonewalling is not necessarily a bad thing for stocks.

Remember what we said earlier: Wall Street hates uncertainty. Sure, a split Congress might be inefficient and therefore incapable of producing major legislation, but so long as investors have time to establish that environment as what is expected, stocks might not get punished.

David believes that investors have been pricing in this scenario over the past few weeks, so simply moving past the uncertainty of the elections and into a world where the expected results hold up could inspire a post-midterm rally for stocks.

The reverse of this would be the shock value of Democrats taking control of both branches of Congress, which might result in near-term bearishness for stocks. Wall Street does not like to be either wrong or surprised, so it could take time for this reality to settle in. With a Republican in the White House, however, any major legislation would still require bipartisan talks.

Long-Term Effects

There is also a question of whether Republicans and Democrats might actually be able be able to hash out an infrastructure deal, as that goal has been adopted in both parties’ platforms. Bipartisan agreements have been few and far between throughout the course of this decade, but infrastructure spending is necessary and not especially polarizing, so there is hope.

Infrastructure negotiations would almost certainly be long and grueling, but Wall Street would likely reward traditional industrial plays such as Caterpillar (NYSE:CAT) to be the eventual winners of a deal. The extent of such a package could help buoy infrastructure-adjacent businesses for years to come.

Some analysts have suggested other areas of bipartisan agreement could become negotiating points. In a recent note, Cowen highlighted “everything from infrastructure and drug pricing, to a federal minimum wage hike and student debt relief” as “potential areas of compromise.”

However, Wall Street appears to generally believe that the midterms will have muted long-term effects on the market. There simply is not enough evidence to suggest that midterms materially affect the fundamentals behind equity prices, and many of the same tailwinds and headwinds will blow at the same strength, regardless of party control.

“While a House majority switch suggests markets returns could disappoint in 2019, we do not see this as pointing to a more protracted economic or equity market downturn. In fact, these midterm switches have not preceded major turning points for markets ever,” wrote Fundstrat Global Advisors.

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