Market Insights

How might the midterm elections ripple through financial markets? There are three possible outcomes in tomorrow’s midterm elections:

• Republicans retain control of both houses of Congress.
• Democrats take the House but not the Senate.
• Democrats win big and seize control of both the House and the Senate.

If Republicans maintain or extend their grip on Congress, President Donald Trump may be encouraged to pursue more of his political agenda, including further tax reforms.

In last Thursday’s Morning Market Briefing, Price Headley of BigTrends.com said he believes that “if Democrats win the House and Republicans retain control of the Senate, legislative gridlock may reduce the chances of major policy changes. Wall Street likes gridlock.”

But say the Democrats manage to take the House of Representatives, and possibly the Senate. That could stifle Trump’s policy aims and perhaps lead to attempts to impeach him.

History favors a split Congress as the likely outcome, with Democrats winning the House but not the Senate. Democrats need a net gain of 23 seats to take the House, a margin of victory well within the norm for midterms because the president’s party typically loses ground.

In 2010, for example, President Obama’s Democrats lost 63 seats. In the 2006 midterms, President Bush’s Republicans lost 27 seats. In both cases, the president’s party lost control of the House.

Markets may have already priced in a Democratic victory in the House and split control of Congress. If that is the case, there could be a traditional relief rally once the election is over.

Historically, stocks struggle in the weeks before a midterm, then upswing once the voting is over. If Republicans surprise by keeping control of Congress, that opens the door to further tax cuts and other business-friendly measures, which would probably give stocks an added boost. But if Democrats sweep both houses, markets could take it as a sign that voters want a rollback of the Trump tax cuts, more regulation and more costly social programs. That could hurt stocks.

Political and financial writers have been quick to say that midterm congressional elections are rarely major U.S. market events, let alone a global market event, but this time could be different.