As Americans vote in the midterm elections hours from now, history suggests that the stock market could sink if the current administration loses control of the House of Representatives (the lower chamber of the Congress). Stocks tend to be volatile during a midterm election year. Since 1962, the average correction in a midterm year has been a staggering -19%.
The GOP currently controls the House with a 43-seat majority, but Democrats are widely expected to gain control. Republicans are also in control of the Senate, with Democrats having to protect 26 out of the 35 seats up for grabs this year.
Historically, the opposition typically wins more seats in the House during the midterm elections. In addition, a big number of Republican lawmakers are retiring this year, meaning that more seats are up for grabs by either party.
If the Democratic Party takes the House, there is a high possibility that it will create new laws and/or policies, while keeping a firm check on President Trump. In fact, some of his harshest critics of from the Democratic Party are among those likely to head key committees if there is a shift in the balance of power.
A win for Democrats is likely to cause an immediate fall in stocks as investors try to work out the potential implications, which include investigations into the President and possible impeachment hearings.
Both parties may also decide to work together with regards to infrastructure development. Nonetheless, there is always the likelihood that a new bill may be scuttled for political gains by one or other party, which would be devastating for investors.
If Republicans keep control of the Senate and House, a relief rally is almost certain. However, a new era of uncertainty is likely to follow as the President doubles down on his policies.
Investors do not like policy and political uncertainty. Nonetheless, once a midterm election ends, they are usually at ease and have a clear picture of what to expect from the House for the remainder of the term. Perhaps this is why in seven decades, the S&P 500 index has not sunk in the 12-month period following a midterm election.
The average price return in the twelve months after a midterm election from 1950 to 2014 was +15.3%, according to The Wall Street Journal. The S&P 500 Index has rallied nearly 24% since Trump won the White House race in the 2016 election. However, the index is down for the year, due to high interest rates set by the Federal Reserve as well as fading benefits of deregulation and tax cuts.
The US stock market is already on a bull run heading into the elections, and some analysts believe that a political shift is likely to create small losers and winners, as opposed to toppling the strong footing.