Explaining the US mid-terms and what they mean

Can you remember a time when the mainstream UK media followed American mid-term elections with such fervour? Recently, we seem to have been lambasted with every possible twist and turn both before and after these elections. Of course, it all comes down to one man – Donald Trump. These mid-terms are widely regarded as a referendum on Trump and, are estimated to be the most expensive election of their type in history with expenditure reportedly reaching $7.2 billion, dwarfing the previous record of $4.2 billion. They are certainly the most fractious that we can recall.

What are the mid-terms?

The US mid-terms are conducted during the second year (or ‘mid’ way through) a president’s 4 year ‘term’. The vote is used to elect congressmen and senators to the House of Representatives (House) and the Senate respectively. The amalgam of these two entities form Congress, which equates to our parliament, and is used to pass legislation or policies.

What happened in Tuesday’s election?

Prior to Tuesday’s vote, both chambers were controlled by Republicans thus making it easier for Tump to impose his political agenda. Numerically, the House has 435 seats available; 240 controlled by Republicans and 195 controlled by Democrats. In the 100 seat Senate, 51 seats were held by Republicans whilst Democrats held 49.

Tuesday’s vote has now changed the balance of power. Republicans have retained control of the Senate, with a slight extended lead, but they have lost control of the House. Democrats now control 225 seats in the House, with Republicans only having 197 seats. This means congress is in ‘Grid-lock’.

What could the ramifications of ‘grid-lock’ in Congress be?

Whilst grid-lock in the government may sound severe, there has been a lot of evidence to suggest it is in fact generally beneficial in several ways. For example, Ken Fisher, an investment historian and reporter for the FT, describes an extraordinary tendency for stock prices to rise in the fourth quarter following a mid-term election. This effect, he says, continues for two consecutive quarters. The effect described happened during Obama’s last mid-term. Mr Fisher suggests this is now likely to be the case.

One obvious question is why would political gridlock be good for wealth creation? It is thought that a divided Congress tends to agree only on issues that command strong bi-partisan support. Broad agreement to get things done is translated as being beneficial for investors.

Historic data shows that stock returns during the first two years of a presidency tend to be weaker than the latter two. The impact during the election month of November has also been measured. On average, the monthly return during a mid-term is 1.91% versus 0.29% in the month of November when it coincides with a presidential election year. The average return during November, year on year, is 1.11%.  In the grand scale of things, the differential is not hugely meaningful. However, what is interesting is that since 1939 the third year of a US president’s term has never resulted in negative returns in the US stock market.

Although the pace of growth in the US may begin to slow as the effects of the fiscal stimulus wear off, historic evidence suggests the mid-term results of gridlock are not normally negative for the economy. If the positive effect on the stock market holds true one could argue that this will mitigate fears of an economic slowdown.  At times the stock market can operate as both cause and effect. In other words, a stronger stock market may prolong the economic upturn.