Nearly halfway into 2018, it’s become even clearer that the calm that enveloped the stock market in 2017 was far from normal. US trade policy, inflation fears, and big-tech regulation are just a few of the issues that have rocked markets this year.
Goldman Sachs is now flagging another potential source of volatility on the horizon: the US midterm elections on November 6, when seats in the House of Representatives and Senate will be contested.
“Policy uncertainty and equity volatility usually register above average during midterm election years, rising in particular during the three months ahead of the election,” David Kostin, Goldman’s chief US equity strategist, said in a note on Thursday.
“US equities typically trade sideways during this period but rally around the election as uncertainty fades. Upcoming elections are one reason to expect that current elevated levels of uncertainty will persist in coming months.”
This year, Republicans will contest to hold on to their majority seats in both chambers of Congress. They’re looking to avoid what happened to Democrats in 2010, when Republicans took over the House.
Kostin noted prediction market data compiled by PredictIt.org, which suggests that Democrats will win the House, but Republicans will keep their Senate majority, creating a divided government.
“The current political environment suggests that uncertainty and volatility may remain elevated post-election given the likelihood that a divided government leads to an increase in congressional investigations,” Kostin said.
While Kostin forecasts more volatile markets leading up to the election, there’s much less clarity on where stocks could go after it. S&P 500 returns have varied widely following Democratic victories relative to Republican wins in the House. Also, a minority party has flipped the House in only three out of the last 11 midterm elections, so there’s not much historical precedent for what prediction markets are betting on.
And so, Kostin cautioned that investors shouldn’t rely on the small sample of sector returns around midterm election years.
“Historical correlations with policy uncertainty may be a more useful guide,” he said, adding that defensive sectors tend to outperform when policy uncertainty rises, while tech and financials perform the worst.
Three specific issues will be in focus before and after election day, Kostin said: healthcare costs and drug pricing, government spending, and deregulation.
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