Giorgio "Joe" Vintani
US Mid-Term Elections 2022
Big Wheel keeps on turning (turning) !
In Full Swing
The mid-term elections in the US are in full swing, and at the moment of writing it looks as though President Biden is set to avoid the worst-case scenario of losing both the Chamber and the Senate; though it will be more difficult for him to push forward with his agenda in the next two years that lead to the Presidential Election in 2024. Interestingly, while the mid-term elections are often a way to punish the president in charge, they are not always a good predictor of the next presidential election - even President Obama lost the midterms in his first mandate and then went on to be re-elected in 2012. In fact, since 1900, the incumbent President's party added to their tally of seats on just 4 occasions: in 1902, with President Theodore Roosevelt (Republican); in 1932, with President Franklin Delano Roosevelt (Democrat); in 1998, with President Bill Clinton (Democrat) and in 2002 with president George W. Bush (Republican).
What are the possible outcomes?
In the chart below, you can see three possible outcomes of the midterm election and their likely consequence on the economy and spending:
Source: U.S. Bank Asset Management Group
While the elections are widely followed in the US and around the world, the corporate world seems not to be too focused on it, as highlighted in the below chart from FactSet. They are likely to follow closely what happens in Washington, albeit not in the Capitol - their obvious target is the Federal Reserve. This is going to be influenced by politics anyway, as the two parties have different objectives: Republicans prefer to give the Fed a strong mandate to lower inflation, while Democrats prefer to keep unemployment low. Tomorrow's CPI and subsequent data will be key in determining how hawkish the Fed can be. If the houses are split, as it seems likely, fiscal spending will be lower, with fewer issues of treasuries. This does benefit the rates and fixed income markets, and also risky assets including equities, adding to the positive elements that are in place after midterm elections.
It is interesting to note that this year the market has focused more on the Fed and the economy than on politics, and consequently had a dismal performance relative to what normally happens in midterm years.
Source: Charles Schwab, Bloomberg
Rolling, rolling, rolling on the river...
So why do midterm elections usually produce a boost for stocks? It is because a divided government points to a lower likelihood of major changes in legislation, and if the Republicans can control one house, this could mean that the opposition will likely hamper any spending plans by the government. This in turn could hopefully lower spending and hence inflation, putting an end to the Fed's very ambitious hiking program. The chart below highlights that from a historical performance perspective, we should be on a sweet spot at least for the next six months:
Source: Carson Investment Research
This is echoed by the below chart for the Dow, though it seems ominous to say that the worst is behind us on a year in which the S&P 500 is down -19.7% as of yesterday, and on the evening before the publication of the October CPI which can be once again a game changer (either way).
Source: The Lyons Share
On a sector basis, a Republican sweep would be advantageous for energy, defense, and healthcare and at the margin for technology as well. Looking at the broader market, analysts still expect the S&P to produce earnings growth throughout 2022, even though there will be a dip in 4Q22.
The chart below highlights how growth estimates for 4Q22 have changed since July, in synch with the Fed's hiking.
In terms of valuations, the chart below shows that the current forward P/E Ratio for the S&P 500 ( 16.1) is below both the 5 Year Average (18.5) and the 10 Year Average (17.1).
In the chart below we can see the US economic growth through the Presidential cycle. We are wondering what will happen next year and whether it is still possible that the US Economy will avoid a recession.
Source: Bloomberg, AMP
Some folks are born made to wave the flag! Oohh, they are red, white and blue!
(Creedence Clearwater Revival)
What if growth is actually not that bad? Goldman Sachs is optimistic that we just might be able to avoid a recession. Its well-respected Chief Economist Jan Hatzius says that there is only a 35% chance that the US Economy might enter a recession in 12 months' time. I feel very much in tune with his view. While this is double the risk of a recession occurring in any given year, because of high inflation, the Fed's tightening program, and uncertain (to say the least!) geopolitics, it is significantly less than the 63% probability arising from a recent Wall Street Journal survey. The US 3Q22 GDP grew at a 2.6% pace, meaning that there is still some way to go before it enters a recession. Hatzius thinks the Fed should bring down growth to below trend but with a positive rate, cooling the job market with only a limited increase in unemployment, tempering wage growth and last but not least directing inflation lower towards a path to 2%. There is evidence that the Fed is having some success in cooling the job market and tempering wage growth, as shown by the last Non-Farm Payroll.
In the end, we can conclude that politics matters, but the economy's way more important. Good luck with tomorrow's CPI! And remember: it is always darkest before dawn!
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