5 ways the midterm elections could impact markets

U.S. midterm elections and a possible shift in the balance of power in Congress could have a profound effect on the economy — and other key issues — moving forward. Democrats currently control the House of Representatives by a margin of 220 to 212 and the Senate thanks to Vice President Kamala Harris’ vote breaking a 50-50 tie. This has many investors trying to gauge the potential impact on the financial markets.

Heading into Election Day, Republicans are currently expected to take control of the House, while the race for the Senate is considered a toss-up, according to polling site FiveThirtyEight. A potential “red wave” of Republican victories could have a major impact on how much the Biden administration can hope to accomplish during the next two years, including the direction of the economy.

How the midterm elections could impact investors

The stock market has had a rough 2022, but if past midterm elections are any indication, there could be some relief on the way. In 17 of the 19 midterms since 1946, stocks performed better in the six months following an election than they did in the six months leading up to one, according to data from Charles Schwab. However, that record could get tested this year as investors face the headwinds of high inflation, rising interest rates and a possible recession.

Here are five other areas where the midterms could influence markets.

1. Taxes

If Democrats pull off an upset and maintain control of both the House and Senate, it could allow them to revisit efforts to raise taxes on high earners, capital gains or corporations. If Republicans control either the House or Senate, tax hikes would likely be off the table.

Tax hikes would likely be viewed negatively by investors because of the potential negative impact on the economy and corporations. All else equal, higher tax rates for companies mean lower market valuations.

2. Energy

Broadly speaking, Democrats have had a greater focus on the impact of climate change and have been more supportive of policies that limit carbon emissions. If Republicans gain control of Congress, they could look to encourage greater production of oil and gas. This could boost energy companies involved in exploration and production, but it could also bring down the price of oil. Energy stocks could benefit from a boost in production, but it could be somewhat neutralized by lower energy prices.

However, if Democrats were to maintain control of Congress, clean energy companies may further benefit from policies that encourage investment in renewable energy sources such as wind or solar.

3. Defense spending

Defense spending is likely to rise no matter who controls Congress following the midterms, but it’s likely to rise most significantly under Republican control, according to UBS Wealth Management.

As the Russia-Ukraine War continues and tensions with China increase, there is bipartisan support for an increase in defense spending. This could be a boon for certain defense stocks.

4. Cannabis policy

Democrats are more likely to support policies that would further grow the reach of the cannabis industry, so Republicans gaining control of either the House or Senate could slow or limit any new pro-cannabis legislation in the near future.

Cannabis advocates would like to see it legalized at the federal level, in part, because it would make it easier for the cannabis industry to obtain financing from major banks. But that kind of legislation is unlikely if Republicans are able to win back either chamber, according to UBS.

(Consider whether these cannabis stocks and funds are right for your portfolio.)

5. Debt limit

The decision by Congress to raise the debt limit has, at times, been a contentious one in recent years. As a new deadline approaches and Congress drags its feet on raising the limit, financial markets can sometimes be volatile, though an agreement often seems to be reached at the last minute in order to avoid a true crisis.

Republicans gaining control of either chamber of Congress could make it more likely that a standoff over the debt limit will happen again, while a Democratic sweep would likely make raising the debt limit a non-issue that can be kicked further down the road for the next two years.

Bottom line

While much attention will be paid to the results of the midterm elections, long-term investors shouldn’t make drastic changes to their portfolios as a result of the outcome. While some industries may benefit or be harmed more than others because of who controls Congress, predicting investment winners based on election results isn’t always as easy as it seems.

Most investors should stick to their long-term plans and remember that the stock market has advanced at about 10 percent annually over the long term, including periods when both Democrats and Republicans have had control of Congress.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.