How Stocks Tend to Perform If Midterm Elections Lead to Divided Government

Traders work on the floor of the New York Stock Exchange during morning trading in New York City, on Nov. 2, 2022. Michael M. Santiago/Getty Images

The U.S. midterm elections are not only an event that decides the fate of political power in Congress but also something that affects the stock markets.

In a note to clients, Jim Reid, a markets strategist at Deutsche Bank, pointed out that midterm elections are one of the “best historical buy signals for equities,” according to The New York Times.

Since 1950, the S&P 500 Index has moved up in the year following a midterm election, regardless of the party in power. The index historically has risen by 17.5 percent on a 52-week basis when Americans chose a Republican-controlled Congress and a Democratic president, the media outlet said, citing LPL Financial.

“A split government would be good because nothing would get done, and we’ll get no more uncertainty for the next two years,” Kim Forrest, chief investment officer at Bokeh Capital Partners, told Bloomberg.

“Businesses can operate when they know what the playing field is, and if Republicans control Congress amid a Democratic president, that will bring U.S. companies some certainty.”

Investors would be hoping for the historical trend to once again materialize, especially since the S&P 500 has been battered down by 21 percent this year.

However, the past need not repeat this time, as the current scenario is complicated by the fact that the Federal Reserve is looking to raise interest rates in a bid to contain inflation.

Fed Chair Jerome Powell has indicated that more rate hikes might be coming. Higher rates are usually bad news for the economy, business, and, consequently, stock values.

As such, whether U.S. stock markets will be able to rally post the midterms, as in the past, is something that remains to be seen.

Historical Political Trend, Strong Sectors

According to RealClear Politics, President Joe Biden currently has an approval rating of 42.1. A Sept. 25 report by Langer Research notes that Biden is “well under water” ahead of the midterms, with a job approval rate of only 30 percent.

“In midterm elections since 1946, when a president has had more than 50 percent job approval, his party has lost an average of 14 seats. When the president’s approval has been less than 50 percent—as Biden’s is by a considerable margin now—his party has lost an average of 37 seats,” the report stated.

A Republican win in the elections can prove to be very beneficial to stocks from certain sectors. UBS Global Wealth Management, for example, expects a GOP win to set the stage for defense spending to rise “significantly,” according to Reuters.

This would put shares of defense contractors like Raytheon Technologies and Lockheed Martin in the spotlight. Citi analysts expect Republican control of the House and Senate to result in more domestic energy production, which could be favorable for oil exploration firms.