With the midterm elections only two weeks away and the potential outcome of a Democratic-controlled House and Republican-majority Senate appearing increasingly probable, stock markets have had plenty of time to adjust to the scenario. A group of analysts from Goldman Sachs Portfolio Strategy Research tallied the new stock performance of several sectors that could be most affected by a divided Congress to infer investors’ views of post-election legislative activity—or the absence thereof.
Fiscal Spending: As defense spending increased over the past two decades, stocks of both aerospace and defense companies such as Boeing and Lockheed Martin handily outperformed the rest of the market. As elections approach the industrials sector especially have had a relative lead on the market. Analyst David Kostin and his team observed a selection of these businesses to infer that the market doesn’t expect a tightening of fiscal policy.
Infrastructure Legislation: Frequently cited as a possible bipartisan, an infrastructure bill would boost companies including Vulcan Materials and Martin Marietta Materials. These companies saw their stock prices jump in the weeks following the 2016 election but have declined in 2018. Recently, a basket of stocks most exposed to infrastructure spending versus the broad materials sector’s relative outperformance has been more muted. According to Kostin, that suggests that the market believes the likelihood of an infrastructure bill to be unchanged with a unified or broken Congress: Notably, it is not currently happening either way.
Drug prices Reform: According to market prices, a divided Congress would be positive for pharmaceutical companies, decreasing the likelihood of passing legislation that could reduce drug pricing. “The performance of pharma stocks has tracked the forecast market probability of a Democratic success in the House, indicating investors consider a divided Congress would lower the odds of significant regulatory changes regarding drug prices,” Kostin wrote. He explained, however, that Democrats win control of both chambers and if predictions are incorrect, healthcare coverage would become the primary attention of the Congress.
Trade Conflicts: Observing the market operation of a basket of U.S. stocks using high China earnings, Kostin noted that the market sees very little promise of an improving China-U.S. trade relationship. These stocks have lagged the S&P 500 by four percentage points in October as the election nears.
For the market as a whole, Kostin believes the biggest risk won’t come until August 2019:
Our political economists anticipate that at December Congress will expand current spending authority to September 30, 2019 and the debt limit will probably be reached in August. If Democrats get control of one or both Houses of Congress, they believe that financial compromise will become more challenging. Because of this, these deadlines would pose a threat to monetary markets. Concerns weighed on equity prices.