Pollsters think Democrats will make gains in Congress.
The November U.S. midterm elections are coming up fast. President Donald Trump and a Republican Congress have implemented several market-moving changes since the last election, but polls suggest Democrats could regain a majority in the House of Representatives. Bank of America economist Joseph Song recently looked at what is on the line for investors this November and how it could impact the market.
The best-case scenario for stocks.
The S&P 500 has performed extremely well under Republican leadership since the 2016 elections, but Song says a change from the status quo may not necessarily be bad news for investors. Song says Republicans have already accomplished many of the goals that drove stocks higher following the 2016 election. Historically, the S&P 500 has performed best under a Republican president when opposing parties control the House and Senate, averaging a 12 percent annual return. However, Song says if Democrats capture both the Senate and the House, investor sentiment and stock prices might take a hit.
Treasury yields may decline.
Song says his base-case scenario of a Democratic House and Republican Senate in 2019 would likely result in a modest decline in U.S. 10-year Treasury yields. If Democrats pull off a surprise Senate victory, he says those 10-year yields could decline by between 0.1 and 0.2 percent, flattening the yield curve further. At the same time, if Republicans hold onto both houses, Song predicts the yield curve could steepen by roughly the same magnitude. Song says the U.S. debt limit will likely remain a central issue in Washington in 2019 regardless of the election's outcome.
Will the dollar stay strong?
The U.S. dollar has been extremely strong in recent months thanks to international trade tensions. Song says the dollar will likely be negatively impacted if Democrats gain control of the House, and even more so if they gain control of the Senate as well. This weakness would be attributed to an increase in perceived political risk, making the U.S. dollar less of a safe bet for international investors. At the same time, a weaker dollar would likely be good for emerging market stocks and commodity mining stocks, such as Newmont Mining Corp. (ticker: NEM) and Vale S.A. (VALE).
Watch for more tax reform.
Tax reform has been the biggest political driver of stock prices since 2016. If Republicans regain control of both houses of Congress, Song says they will likely pursue a second round of tax reform, which will involve making individual tax cuts permanent and adding incentives focused on retirement and business innovation. Democrats have said they plan on raising the corporate tax rate to 25 percent and reversing tax cuts for high-income Americans to help pay for their $1 trillion infrastructure investment plan. Higher corporate taxes would almost certainly be an overall negative for U.S. stocks.
There are NAFTA implications.
Stocks that have been negatively impacted by the trade war will likely get no relief, even if Democrats gain control of both houses of Congress. Song says the trade tariffs and other actions Trump implemented do not need congressional approval. However, a new trade agreement to replace NAFTA would require a congressional vote, which would be easier for Trump to gain under a Republican Congress. Song says the current trade deal being discussed would likely get the green light regardless, but a Democrat-controlled Congress could push for labor and trade concessions prior to ultimately approving the deal.
The threat of impeachment.
If Democrats gain control of both houses of Congress, there is a greater possibility that Trump will be impeached. Song says impeachment proceedings would represent the type of market shock that has historically resulted in a 6 percent average S&P 500 sell-off. According to online prediction site PredictIt, there is currently a 47 percent chance Trump is impeached during his first term in office, up from a 38 percent chance three months ago. In the two months prior to the release of the Starr report in 1998, the S&P 500 declined by more than 19 percent.
Health stocks are in chaos.
Republicans' ineffectiveness on health care reform has weighed on health care stocks. Song says investors have been avoiding the sector due to all of the uncertainty, despite strong second-quarter earnings. Bank of America analyst Kevin Fischbeck says a Republican sweep in November could be good for managed care operators, such as Centene Corp. (CNC) and Anthem (ANTM). A Democratic sweep would be good news for health care facility stocks, such as HCA Healthcare (HCA) and Tenet Healthcare (THC). However, Fishbeck says any progress toward a single-payer system would be a negative for the sector across the board.
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