US midterm election results roll in: How will they impact the stock market?

Stocks on Wall Street ended higher ahead of the US midterm election results.

With the US Federal Reserve refusing to pivot on its aggressive monetary policy tightening, global investors now peg their hopes on the results of the US midterm elections, which will determine control of Congress.

Wall Street ended higher overnight during voting, with the Dow Jones Industrial Average the best-performing of the major indices, rising 1.02%. The S&P 500 climbed 0.56% and the tech-heavy Nasdaq gained 0.49%.

All 435 House of Representative seats and some 35 seats in the US Senate are on the ballot.

Results start trickling in on Wednesday AEDT. Analysts said it could take days of waiting before it becomes clear who won certain races.

Why is the midterm election important for markets?

Markets are betting that the midterm elections will result in a split government that will possibly hinder Democratic President Joe Biden’s agenda.

“So-called political gridlock is seen as positive for the share market as it could crimp White House plans for more government spending,” CommSec chief economist Craig James said in a note.

The sitting president’s party typically sheds some level of power during these elections, splitting the executive and legislative branches of the US government.

A split government stymies major policy changes, an outcome that investors see as favourable for equities.

The correlation between stock market performance and midterm elections is well-documented. In 17 of the 19 midterms since 1946, the market performed better in the 6 months following an election than it did in the 6 months leading up to it.

That is something investors would welcome after a year in which the S&P 500 has declined by nearly 20%.

What is likely to be the result?

Markets are expecting Republicans to take back the House of Representatives and possibly win the US Senate as well when results start rolling in.

Investors tend to like the notion of gridlock in Washington with a divided Congress and president because it will limit government spending, new taxes and regulations.

The stalemate typically results in lawmakers being unable or unwilling to agree on major legislation. This means substantial laws are either not approved or significantly reduced in scope and impact, said Nigel Green, chief executive of independent financial advisory deVere Group.

“A lack of sweeping legislative changes means there is less uncertainty for businesses.”

“The status quo usually means that corporations can push on with their plans and investments without the risk of everything being upended by new laws and requirements,” Green added.

On the other hand, a surprise Democratic win in the House and Senate would strengthen President Biden’s hand and likely weigh on equities, as market participants might expect additional corporate tax increases.

Which sectors will see the biggest impact?

The following sectors are expected to be more impacted than others:

Big tech: The broad expectation is that reforms to legislation on big technology firms such as Meta, Google and Amazon could come to a halt due to the political gridlock. There is likely to be an upside for the battered tech stocks.

Energy: Energy stocks have been the best performers so far in 2022 and could see a further boost should Republicans take at least one of the chambers. That is because a windfall tax on oil producers proposed by Democrats is likely to get blocked while policies to encourage more US energy production are also likely.

Healthcare: Pharmaceutical and biotech stocks could also capitalise on a Republican victory after Democrats recently pushed through a law aimed at lowering prescription drug prices.

Still, the overall impact on the markets could be limited given the increasing risk of inflation and a threat to the US government borrowing limit in case of a political deadlock.

“A Republican win will generally be positive for equities, but the inflationary risk is unlikely to be mitigated nor accelerated. Inflation risk is still the key risk in the system,” said Ash Alankar, head of global asset allocation at Janus Henderson Investors.