George Brown, Economist at Schroders
Washington is on course for a divided Congress after Republicans failed to capitalise on voter discontent. But history suggests resulting policy inertia could be helpful to investors. Capitol Hill is set for legislative gridlock, with the Democrats having denied Republicans their hoped-for sweep. But where does that leave markets?
Our analysis shows this outcome ought to be supportive of risk assets. US equities have averaged annual gains of 12.9% when Congress has been split, compared to a more modest increase of 6.7% when a Democratic president has controlled both chambers.
But as all investors know, past performance is not a guide to future returns. Risks include the possibility of a debt ceiling standoff next year. Back in 2011, a similar showdown wiped nearly 20% off the S&P 500.
Importantly, attention will now turn to the 2024 presidential election. While Biden has said his “intention is to run again”, he faces an uphill battle for a second term. Dogged by low approval ratings, midterm exit polls show two-thirds of voters do not want him to seek a second term. And so despite his incumbency advantage, Betfair odds imply just a 20% likelihood that he will win the next presidential election.
On the Republican side, Donald Trump’s third bid for the White House has been dented by many of the candidates he endorsed in the midterms underperforming. And he could face stiff competition for the GOP nomination by Ron DeSantis, the bookies’ favourite to be the next president, having just been re-elected as Governor of Florida by a landslide 19 points. However, a bitter showdown between the two could create a deep rift in the party that aids the Democrats.
Backdrop to a surprising midterm outcome
The odds were stacked against the Democrats heading into the midterms. One of the most ironclad rules in US politics is that the president’s party performs poorly in what is seen as a “referendum on the occupant of the White House”. And with President Joe Biden suffering from an abysmal approval rating – coming during the highest inflation for a generation – the Republicans appeared well placed to flip both the House of Representatives and the Senate.
But predictions of a “red wave” proved far off the mark. While a number of races have yet to be called, NBC News projects the Democrats have limited losses in the House to a net eight seats, albeit enough to hand Republicans a slim three seat majority. Whereas in the Senate, they have managed to retain their wafer-thin margin and may even come away with an additional seat to boot.
So where did it go wrong for the Grand Old Party (GOP) and what might the implications be?
House: GOP set for a slim majority
All 435 seats of the House are contested in midterm elections, making it susceptible to national swings in sentiment. Top of American’s concerns this year has been inflation, with three-quarters of voters saying it had caused them severe or moderate hardship. But this was closely followed by abortion rights after the conservative-leaning Supreme Court repealed Roe v. Wade.
This proved pivotal given the partisan divide on the issue between the two parties. Exit polls show that 61% of voters were unhappy with the decision, of which 7 in 10 backed a Democratic candidate for the House. It also didn’t help that the GOP fielded a number of extreme candidates aligned with former president Donald Trump, which were shunned by moderate swing voters.
But while Republicans performed poorly on a national level, they did well in the deep blue state of New York. Redistricting played a part, with the once-a-decade process favouring them. As did their law and order messaging amidst rising crime rates in the state. Also, New York’s long-codified right to abortion meant civil liberties concerns did not play as much of a role as it did in the likes of Michigan and Kentucky. All in all, this resulted in a net gain of four seats in the state.
Senate: Democrats retain control
With the Senate evenly split 50-50, Republicans only needed to pick up one seat to seize control. But unlike the House, only a third of the chamber was up for grabs. And with the majority of these either solidly red or blue, the contest ultimately came down to three tight races; Georgia, Nevada and Pennsylvania. Again, abortion rights and candidate quality made all the difference here.
In Nevada, incumbent Catherine Cortez Masto fended off her election-denying GOP challenger. Whereas the pro-choice vote helped John Fetterman pick up a seat for the Democrats in Pennsylvania, despite suffering a stroke which kept him off the campaign trail. And in Georgia, senator Raphael Warnock edged out his scandal-ridden Republican rival by 38,000 votes. However he was just short of 50% of the vote, necessitating a runoff election on 6 December.
Historically, these have favoured the Republicans as the drop in turnout disproportionately affects Democrats. But Warnock avoided this pitfall two years ago, partly due to Trump’s false claims of election fraud. And this year, he will be helped by the fact that control of the Senate is not at stake. This could see GOP-sympathisers sit on the sidelines or offer only muted support, especially given Walker’s numerous controversies.