Midterm Election Analysis

November 7, 2018

WARNING: tomorrow's election outcome will determine the very future of our Democracy.
Or not. In fact, you can add the above to all of the other ridiculous and exasperating nostrums being cast about of late.
Wednesday morning? I'll miss the political attack ads. The venomous vitriol. The half-true allusions. The far-flung aspersions. And the embarrassing quantities of negativity we are forced to endure in support of what should be one of our most joyous annual occasions. The day on which we exercise our rights as free, liberty-loving members of this greatest constitutional republic on earth.
Most people tolerate these caustic incursions into their lives in the same way they contend with hemorrhoids. Largely ignoring them. Biting one's lip when the discomfort gets too high. And waiting for that blessed moment when these painful annoyances dissipate into memory.

Likewise, we'll tolerate the annoyance for now. And await Tuesday's election results in the way that no less than Warren Buffett has counseled. Not letting the sour taste of politics encroach upon that which is truly important to us. Because, inevitably, the political winds will change. But our family, friends, health and finances will dictate our contentment for years to come.
Doffing our political analyst's caps, what do we foresee on Tuesday?
The House:
With 23 GOP Congressional members retiring, the lower chamber sees Democrats facing a target-rich environment. Requiring only 24 new seats to reclaim the Speakership. And providing what was until recently a relatively easy path to victory. Only, the margin of error has narrowed. As polls showed Democrats holding wider victory margins two weeks ago. And the GOP is pinning its hopes on the pollsters reading the tea leaves incorrectly once again. A la 2016. Yet, lightening in a bottle is hard to come by in consecutive elections. And American political tradition has the incumbent party typically losing Congressional seats in the midterms. We've little reason to forecast otherwise.
A consensus outlook based on the current ratings of Sabato's Crystal Ball, The Cook Political Report and Inside Elections predict 209 firm Democratic House seats. With Republicans firmly maintaining 197. 29 seats remain within the margin of error. Making them too close to call. But a plurality of those currently lean Democrat. Placing momentum in tomorrow's House vote in the Democrat's camp. Though, given the slim margins, it seems that strategists on both sides are not ruling anything out.
The Senate:
The GOP remains heavily favored to hold, or even boost, its 51-49 advantage in the Senate. And current polling suggests the GOP have an opportunity to flip at least one Democratic seat. Yet, should a few individual contests swing towards Democrats? The outcome would be dramatically altered.
The problem for Senate Democrats is the limited number of seats that are truly in play. Those are Democratic-held Indiana, Florida, Missouri, Montana and North Dakota. As well as GOP-held Arizona, Nevada, Tennessee and Texas. Though they appear to be less competitive than others, a surprise in Republican-held Mississippi or Democratic-held New Jersey could also swing the majority.
A race-by-race breakdown shows how difficult it will be for Democrats to gain the two net seats needed to take Senate control. Even if Democrats win their two best pickup opportunities -- Arizona and Nevada -- they have to win at least one more challenging red-state race. That would mean Democratic Senator Heidi Heitkamp would have to defend her seat in red North Dakota. And she has recently trailed. Or, Democrats would have to win one of the Republican-leaning contests in Texas, Tennessee or Mississippi. In that scenario, Democrats would still have to hold every other vulnerable seat such as Indiana, Florida and Missouri to flip two net seats.
A consensus outlook shows Republicans with 50 seats in their favor. While Democrats have 44 in theirs. Six seats remain within the margin of error, though they currently lean Republican.
Of the 36 governorships on tomorrow's ballot, 26 are currently held by Republicans, nine by Democrats, and one is independent. And consensus forecasts show Democrats grabbing net Gubernatorial gains. With hotly contested battles being pitched in Ohio, Florida, Georgia, Maine, Wisconsin, Iowa, South Dakota, Kansas, Oregon and Nevada.
When the smoke clears, Democrats will hold more governorships than the day before. But not enough to eclipse the GOP's current edge. As Republicans have 22 governor's mansions leaning their way, and Democrats have 18. Yet, with 10 races still within the statistical margin or error, anything could happen here. Perhaps even providing the day's one big surprise outcome.
Take-Away Analysis:
The million-dollar question: is Tuesday's election outcome priced into the market?
You'd think so. As polls so firmly suggest that Democrats will take over House leadership. That such an outcome would already be discounted. Though we suspect investors have avoided making big bets. And as a result, a decisive win for either Democrats or the GOP could yield a big swing.
If the probable outcome occurs, that being Democrats win the House and Republicans hold the Senate, then the market will likely assume a negative posture. Albeit temporarily. The uncertainty around Democrats' intentions regarding some of the pro-growth, pro-market policies the administration has enacted have investors on edge. With investors worried that the Democratic leadership might immediately begin talking tax hikes (personal and corporate). As well as the reinstatement of some of the regulatory strictures that were removed on American businesses. Which many analysts believe have helped enhance economic growth the last two years.
If the GOP pulls off the improbable hold in the House, then the market will likely assume a positive posture. Believing in the unabated continuance of current pro-growth policies. Though any rally strictly based on this narrow rational would likely be short-lived.
Either way, institutional research firm Strategas leans on history to argue that equities will fare well no matter which side wins on Tuesday. Their research shows that the S&P 500 has risen in the year after every midterm election since 1946. The analysts attributed this to investors redeploying funds kept on the sidelines ahead of elections. As well as the market's general historical upside bias.
Datatrek Research analysts provide slightly different findings. Though still holding a similar theme, depending on when you begin your historical analysis.
DataTrek reports that in the 1974 midterm, from October 31 to December 31, the S&P 500 fell 7.2 percent. That was the bear market year (-26 percent) when President Ford pardoned President Nixon and oil prices soared due to Middle East tensions. Then in the '94 midterms, the October 31 to December 31 stretch was -2.8 percent amid the Fed's aggressive rate-hiking regime and a concurrent recession. And finally, in the '02 midterms, the second dot-com bear market year (overall -22 percent), the October 31 to December 31 period was -0.7 percent. In other words, all the years in which stocks failed to rise after the midterms were already bad years. Which does not apply to this year. At least not yet.
Finally, Yardeni Research provides a similar historical point: The S&P 500 has risen in the 12 months following every mid-term election since 1950. Which is to say, no long-term bear markets have begun or occurred in that time frame in the last seven decades. Of course, we know there's a first time for everything. But, statistically, chances remain low.
Markets have long remained largely indifferent to D.C.'s political ebb and flow. Especially when gridlock seems to be on the docket. Which a split legislature will likely ensure. Preventing politicians from interfering in what has developed into an otherwise positive economic climate.
In a world of 24/7 information flow, the trick will remain separating the signal from the noise. Regardless of tomorrow's political outcome. Let's not let short-term political noise incite behavior that we'll regret. Because Mr. Market is non-partisan and A-political. And one never knows what kind of surprises he has up his sleeve.

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