Mid-Term Elections And The Economy

OCEAN CITY — With the elections on Nov. 4, investors are increasingly focusing on the campaigning. There are a number of significant Senate races, and an unusually large number of gubernatorial contests. Historically we have seen only a modest pickup in the level of equity volatility in months preceding U.S. midterm elections.

Election tensions do, however, bring some policy uncertainty to markets. Strategas, an independent research firm, notes that equities historically have traded lower in a midterm election year until right before the voting and then rallied through the election. As noted by our BofAML U.S. Equity Strategy team, the net effect generally has been equity rallies for the midterm election years. Over the previous 39 election years, the median return for the S&P 500 index was 8%, while for the most recent 19 midterm election years it was a much stronger 14%.

We believe the election’s effect on the economy and markets is likely to be minimal once we move beyond the voting.

Our colleagues in BofAML Global Economics Research expect the current climate of political polarization to continue, leaving little room for legislative breakthroughs in the next two years.

One by-product of the fiscal challenges facing a divided Congress in recent years has been gridlock, resulting in increased political uncertainty. Over the past few years, reductions in government spending have detracted from growth in U.S. gross domestic product. This “fiscal drag” is expected to moderate going forward.

Historically, brinksmanship from U.S. policy makers has kept a lid on business confidence. We expect the strong public backlash against last year’s government shutdown to prevent a similar situation this year, helping maintain lower levels of policy uncertainty, which should lead to improving business confidence and investment.

Although there’s a possibility that the Republicans will control both chambers of Congress, the Democratic President has two more years to serve, so the government would remain split. In our view, the implications of a Republican-controlled Senate are likely to be limited, with minimal effect on most major policy debates.

(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)