The U.S. Midterm Elections: What to Expect

On November 8, 2022, Americans will go to the polls to determine which party will control Congress alongside several state, municipal, and local contests. In a year that has already seen a fair share of uncertainty, with the war in Ukraine, increased market volatility, and rising inflation, investors may be concerned about further disruption in the markets. However, while the outcome of the election will impact what legislation might stand a chance of getting through a sharply divided Congress, the outcome—whether it's a shift in power or a reinforcement of the status quo—may not have as much of an impact on markets as you might expect.

How likely is a shift in power?

All 435 seats in the US House of Representatives are up for election this year, and Democrats currently hold a slim, 8-seat majority. "Historical trends show that momentum is in favor of the Republican party, and notably there are a historic number of Democratic House retirements," says Alice Joe, a vice president on Fidelity's Government Relations team. "It's typical for control to flip when you have a first-term president who is in the same party that currently controls the House. Looking at 3 of the 4 most recent presidents, Clinton, Obama, and Trump, their respective parties all lost House seats in their first term." In fact, since 1862, the incumbent president's party has lost House seats in 36 out of 40 midterm elections and Senate seats in 13 out of 19.* However, just like with investing, the past does not always predict the future; the House staying under Democratic control remains a possibility.

Source: Bloomberg. In the House chart, blue dots represent seats held by Democrats, red dots represent seats held by Republicans, and gray dots signify vacant seats. In the Senate chart, blue dots represent seats held by Democrats, red dots represent seats held by Republicans, and light blue dots represent seats held by independents who caucus with the Democrats. As of 9/21/2022.

The Senate is currently split 50-50 between Democrats and Republicans, with Vice President Kamala Harris's tiebreaking vote giving Democrats control of the chamber. This cycle, 35 seats are up for election, and several close races are expected.

How will the outcome affect policy?

Should Republicans take control of the House, Alice Joe expects the party to use the chamber's vast oversight powers to take a closer look at many Biden administration policies, such as the recent decision to forgive student loan debt and the withdrawal from Afghanistan. Regulatory agencies will also face more scrutiny, and could be reined in from a more aggressive agenda.

A Republican Senate would present a major roadblock for President Biden, potentially hampering his ability to nominate cabinet officials, judges, and other positions that require Senate confirmation.

Nevertheless, there may be opportunities for bipartisan cooperation, even under divided government. Joe points to the pending SECURE Act 2.0, which would implement reforms around retirement savings, and passed the House in March on a near-unanimous vote. Joe expects the Senate will pass it sometime before the end of this year, regardless of the outcome of the election. "Retirement has always been bipartisan," she says. Additionally, we could see agreement on less polarizing issues, such as defense spending, taxes, or certain health care provisions. In the event that Democrats retain control of both chambers of Congress, Joe believes they may revisit proposals that were initially included in the Build Back Better Act that did not make it into the final Inflation Reduction Act.

How might the outcome affect the market?

"If you're an investor, I would suggest that this shouldn't be something you focus on," says Denise Chisholm, director of quantitative market strategy at Fidelity Investments. "It's my belief that you shouldn't be making big changes in your portfolio because of the election."

Naveen Malwal, an institutional portfolio manager with Strategic Advisers, LLC, the investment manager for many of our clients who have a managed account, agrees. "Historically, we haven't seen a strong relationship between Election Day outcomes and how markets perform from there on out," says Malwal. "So we don't adjust our positioning based solely on election outcomes."

"The election cycle is usually not the dominant theme of the market," says Chisholm. "But the year following the midterm election tends to be the year with the narrowest range of returns—whether or not there's a change in control." In analyzing how markets have performed across election cycles, Chisholm looked at historical data since 1950, tallying up the price returns for the 12-month periods between federal elections.

Past performance is no guarantee of future results. Data spans from November 30, 1950, to August 31, 2022. Years represent the 12-month period from November 30 to November 30 following a US presidential or midterm election. The chart depicts the average, minimum, and maximum price return achieved during this period. Stocks are represented by the S&P 500. Indexes are unmanaged. It is not possible to invest in an index. Source: Haver, FactSet, FMR. As of 9/7/2022.

"Historically, we've seen the best average returns in the 12 months following the midterm elections. The worst average returns with the highest variability in outcomes historically have been in the 12 months preceding the midterm election. The returns are still positive, just not as high. So, in the past, what we've seen is the 12 months following the midterms have had the least amount of variance, and the least amount of downside."

Chisholm says this could be because the resolution of the uncertainty surrounding the election calms investors, but overall feels that markets are largely taking their cues from other developments. "The wide range of outcomes you see in the analysis highlights that it's probably not politics that are driving stock performance. This year, how markets react is likely going to be driven by inflation, or whether investors expect a recession or not, or by what the Federal Reserve does. Politics likely won't have much of an impact."

Adds Malwal, "When managing client accounts, the US business cycle is the primary driver of our investment decisions. That's because we believe the pace of US economic growth and the direction of corporate profits are much stronger drivers of stocks over the long run."