US midterm elections

All investor eyes turn to the US midterm elections

10 October 2022

Henk Potts, London UK, Market Strategist EMEA

Please note: The article does not constitute advice or any form of investment recommendation.

Key points

  • With the US midterm elections coming up in November, history suggests that the president’s party almost always falters – but can Joe Biden and the Democrats defy the odds this time?
  • However, this year could be slightly different to previous years, with a re-energised Democratic base expected to boost turnout and help candidates outperform
  • Control of both the Senate and House of Representatives is at stake. A split or Republican-controlled Congress would hinder Biden’s key spending and tax policies. Whereas a Democratic-controlled Congress could reignite proposals for tax increases
  • US equities tend to underperform going into the midterm vote. Investors should prepare for more volatility in the near term, followed by a potential rally

With US inflation at its highest in four decades, surging interest rates, and a technical recession in the first half of the year, a red wave might be on the cards at November’s midterm elections. However, as the Democrats’ campaign picks up steam, the battle for control of Congress could be a much closer call than first envisaged.

The midterm congressional elections are scheduled for 8 November 2022 and will determine the American policy agenda for the next two years. The United States Congress consists of the House of Representatives and the Senate. The constitution grants Congress the sole authority to enact legislation and declare war.  Senators serve six-year terms, of which one-third are up for election in November. Meanwhile, all 435 members of the US House of Representatives will be elected.

Change in the political winds

Sitting halfway through the presidential four-year term, the midterm elections are traditionally seen as a referendum on the incumbent president. According to a recent Reuters/Ipos opinion poll, President Biden’s approval ratings continue to hover at around their lowest seen in his term in office, with only 39% of respondents approving of his handling of the job1. His approval rating has languished below the 50% mark since August 2021.

History has shown that the governing party invariably loses seats at the midterm elections. President Obama’s Democrats lost 63 seats in the House of Representatives at 2010’s midterms, while the Republicans lost 40 seats in the House in the last midterms. In the forty midterm elections since 1862, the president’s party has lost seats in the House of Representatives 90% of the time.

Despite the worrying historical signs for the Democrats, there are a range of factors that appear to be energising the party’s base. For one, the conservative leaning Supreme Court’s decision to overturn the federal right to an abortion, in the Roe versus Wade ruling, in June appears to have enraged many Democrats. 

Further, the party has delivered a plethora of legislative victories in recent months, including in key policy areas such as the economic recovery packages, infrastructure investment, healthcare reform, and climate-change initiatives.

Money can also be a determining factor in US elections. According to data from the Federal Election Committee, Democrats are noticeably ahead of their main rivals in the fundraising arena. Democratic Senate candidates have raised $526 million, while Republicans trail with $510 million raised2. The re-energised Democratic base has helped to boost turnout as well as candidates to outperform at a range of special elections in recent months. 

Balance of power and key battlegrounds

In the Senate, Democrats hold 48 seats and the Republicans 50 seats. Two Independents caucus with the Democrats. The governing party holds the majority in the Senate due to the tie-breaking vote  of Vice-President Kamala Harris. 

Out of the 100 Senate seats, 35 are up for election this year. Of those 35 seats, 21 are held by Republicans and 14 by Democrats. The electoral cycle may come to the aid of the Democrats too, as they are not defending any seats in states that were won by Trump in the 2020.

The key battleground seats appear to be in Nevada and Georgia, which are held by the Democrats, and Wisconsin and Pennsylvania, which are held by the Republicans. In order to break the current 50-50 tie, it’s considered that Republicans would need to win three of these “too close to call” contests to flip control back into their favour.

House of Representatives

If Democrats were to maintain control of the Senate, Republicans would still be favourites to carry the House of Representatives. Democrats have a majority in 221 seats, with the Republicans holding 212 others, and two vacancies. 

Looking at the races that are typically won by five percentage points or less, political analysts have highlighted around 80 competitive seats. These are likely to determine the outright result. In order to gain a majority, Republicans would need a net gain of six seats, at a minimum. 

The recent fall in petrol prices, robust labour markets, and the stronger fund-raising season has improved the prospects for the Democrats in the House, compared to a few months ago. However, along with the difficult precedent, the fortunes of the party may also be impeded by nearly forty of its incumbents deciding not to seek re-election in November.  

Meanwhile, Republicans are thought to have benefited from the redistricting process, which redraws boundaries to account for changes in population, as highlighted by the census. This procedure is conducted at the start of a new decade and appears to favour the “Grand Old Party” in a number of districts this time around. 

Given the tradition of protest voting, their lower lead in the polls, and structurally higher turnout for Republications, political forecasters believe that the Democrats will lose control of the House after the midterm election.

Impact of a split Congress on policy

A split, or Republican, Congress would impact President Biden’s ability to deliver his key spending and tax policies in the second half of his term. The diffusion of power across the political spectrum would likely constrain Congress when deciding on the appropriate levels of government funding and when assessing expiring provisions. Conversely, a Democratic-controlled Congress could reignite proposals for increases in corporate, capital gains, and income taxes.

Markets and the midterms 

Over the past century, equities have tended to underperform going into the midterm vote. However, as clarity over the political outlook improves, so does the performance of stocks. Therefore, all things being equal, investors should prepare themselves for yet more volatility in the near term, followed by the potential for a rally.

Looking at the performance of equities over the course of the presidential cycle, this shows that the midterm year, on average, delivers lower annualised US stock market returns. History shows that year three (pre-election) has delivered the best returns, followed by year one and then year four.

Somewhat counterintuitively, investors appear to actually prefer a split Congress. The average S&P 500 return when Democrats have held the presidency and Congress was split, has been higher than when government or the Congress is unified. So, perhaps investors would agree with the founding fathers that a balance of power is not only good for politics but also for market returns.

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