What to expect under divided government
We look at the potential impact on policy and the markets.
- Fidelity Wealth Management
- – 12/07/2022
- It’s official: Republicans have won control of the House of Representatives, while Democrats have expanded their majority in the Senate.
- Republicans are likely to pass a series of messaging bills intended to shape the party’s agenda ahead of the 2024 presidential election, though they have little chance of passing into law under divided government.
- Generally speaking, the election cycle has not been the dominant theme for markets and there has not been a strong relationship between Election Day outcomes and market performance.
At last, the votes have all been counted and the outcome of the 2022 midterm elections is clear. However, while the outcome of the election may impact what legislation might stand a chance of getting through Congress in the coming years, it may not have as big of an impact on markets in the longer term as you might expect.
Republicans take the House, Democrats keep the Senate
All 435 seats in the US House of Representatives were up for election this year, but because of how close many of the races were, it was not immediately clear which party would control the House and by how many seats.
However, on December 2, California’s 13th Congressional District completed their counting of the votes—the last in the nation to do so—and determined that Republican Adam Gray would win the seat over his Democratic challenger, John Duarte.
With this, it is projected that Republicans will hold 222 seats in the House of Representatives this year, at least a 10-seat advantage over the Democrats, who are expected to have 212 seats following the recent passing of Virginia congressman Donald McEachin, whose seat will remain vacant until a special election is held.*
Democrats fared far better in the Senate, however, and on December 6, Democratic incumbent Senator Raphael Warnock defeated Republican challenger Herschel Walker in Georgia’s runoff election, resulting in a 51-49 Democratic advantage in the upper chamber.
How will the outcome affect policy?
With Republicans in control of the House, Alice Joe, a vice president on Fidelity’s Government Relations team, expects the party to use the chamber’s vast oversight powers to take a closer look at many Biden administration policies. Regulatory agencies will also face more scrutiny and could be reined in from a more aggressive agenda.
She also believes House Republicans are likely to try to pass bills focused on taxes, energy independence, strengthening the supply chain, and cracking down on illegal immigration and crime. These will be messaging bills that shape a Republican agenda leading up to the 2024 presidential election, with little chance of being enacted into law in the 118th Congress. In the Senate, Democrats will likely be focused on confirming Biden nominees, especially for judicial appointments that could last beyond the duration of the president’s term.
Even under divided government, there could still be opportunities for bipartisan cooperation. Joe points to the pending SECURE Act 2.0, which would implement reforms around retirement savings. Joe expects it to pass as part of a year-end spending bill sometime before the end of 2022. “Retirement has always been bipartisan,” she says. Additionally, we could see agreement on less polarizing issues, such as defense spending, tax extenders, or certain health care provisions.
How might the outcome affect the market?
"If you're an investor, I would suggest that this shouldn't be something you focus on," says Denise Chisholm, director of quantitative market strategy at Fidelity Investments. "It's my belief that you shouldn't be making big changes in your portfolio because of the election."
Naveen Malwal, an institutional portfolio manager with Strategic Advisers, LLC, the investment manager for many of our clients who have a managed account, agrees. "Historically," says Malwal, "we haven't seen a strong relationship between Election Day outcomes and how markets perform from there on out. So we don't adjust our positioning based solely on election outcomes."
"The election cycle is usually not the dominant theme of the market," says Chisholm. "But the year following the midterm elections tends to be the year with the narrowest range of returns—whether or not there's a change in control." In analyzing how markets have performed across election cycles, Chisholm looked at historical data since 1950, tallying up the price returns for the 12-month periods between federal elections.
"Historically," says Chisholm, "we've seen the best average returns in the 12 months following the midterm elections. The worst average returns with the highest variability in outcomes historically have been in the 12 months preceding the midterm election. The returns are still positive, just not as high. So, in the past, what we've seen is the 12 months following the midterms have had the least amount of variance, and the least amount of downside."
Chisholm says this could be because the resolution of the uncertainty surrounding the election calms investors, but overall feels that markets are largely taking their cues from other developments. "The wide range of outcomes you see in the analysis highlights that it's probably not politics that are driving stock performance. How markets react is likely going to be driven by inflation, or whether investors expect a recession or not, or by what the Federal Reserve does. Politics likely won't have much of an impact."
Adds Malwal, "When managing client accounts, the US business cycle is the primary driver of our investment decisions. That's because we believe the pace of US economic growth and the direction of corporate profits are much stronger drivers of stocks over the long run."
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