Taking the Midterm

Americans head to the polls tomorrow.  FiveThirtyEight, the opinion polling aggregation website, predicts an 87% probability that the Democrats take the House and an 83% chance that Republicans hold the Senate.

This is not a surprise.  In 35 out of 38 midterm elections since the Civil War, we have seen the president’s party lose seats in the House. Presidential popularity is typically near its lows around midterm. Notable exceptions include FDR’s first term on excitement regarding the New Deal, JFK’s midterm on the heels of the Cuban Missile Crisis and early in the George Bush presidency in the aftermath of 9/11. Given that Senate terms are six years and House terms are two years, changes in control at the Senate occur less frequently.  While the trend is less clear in the case of the Senate, it’s still not often that the president’s party gains seats.

Voter turnout is expected to be 50%, well above the 40% norm since the 1960’s. It is interesting to note that higher turnout makes it easier to call the race to control the House and the Senate.

All 435 House seats are up for election.  For the balance of power to flip in their favor, the Democrats need to win 23 of the 29 that are said to be up for grabs.  Meanwhile, 35 Senate seats are being contested.  The Democrats need two seats to take control of the Senate out of the nine that are described as toss-ups.

The financial markets appear to be anticipating the most likely scenario - a Democratic majority in the House, but not the Senate -- and its comparatively benign implications for economic policy.  Business-friendly policies would likely be sustained while a semblance of “checks and balances” would return.

Bear in mind, however, that if there is a 13% chance the Republicans maintain control of the House and a 17% chance that the Democrats take the Senate, there is approximately a 30% chance of an upset of some sort. The unexpected outcome is more likely to rattle markets.

  • Republicans maintain control of both houses – expectations for continuing fiscal stimulus in the form of more spending and more tax cuts could raise expectations for inflation and higher interest rates – probably not good for stocks or bonds.
  • Democrats win the Senate, but not the House – this would impact future court appointments, but otherwise implies something close to status quo.
  • Democrats emerge with a majority in both houses – policies don’t change overnight, but this would be interpreted to portend big changes down the road. Markets don’t take kindly to uncertainty.

Many factors ultimately shape returns. A comforting data point is currently making the rounds: since 1946, stocks have been higher one year after every single midterm election. We observe that a 100% track record does not equal inevitability - but we do like those odds!