The Tell: Stock-market investors brace for months of political uncertainty as midterms approach

Investors should brace for even more political uncertainty as the November midterm elections approach, say analysts at Goldman Sachs.

The last several months have already seen markets driven in both directions by trade and tax policy, geopolitical tensions, and developments surrounding Special Counsel Robert Mueller’s probe into whether Trump campaign officials colluded with Russia’s efforts to interfere in the 2016 presidential election.

While there are plenty of fundamental issues that stocks have also traded on—including corporate profits and economic data—politics could become a more potent factor as the elections approach.

Goldman Sachs analysts on Friday wrote that the November midterms represented “yet another source of policy risk and volatility” for stocks, saying they were “one reason to expect that current elevated levels of uncertainty will persist in coming months.”

Volatility was atypically low in 2017, but returned in dramatic fashion earlier this year. Currently, the Cboe Volatility Index VIX, +5.76%  is at 16.49. While this is below its long-term average near 20, it is up 50% so far this year. The Dow Jones Industrial Average DJIA, -0.82%  is down 1% year-to-date while the S&P 500 SPX, -0.85%  is off 0.1%. The Nasdaq Composite Index COMP, -1.27%  remains up 3.8% for the year.

In one chart: The VIX says the stock-market low may be in

According to Goldman’s data, equity markets have averaged 15% volatility over the past 11 midterm years, compared with the median of 12% in all years. Uncertainty related to economic policy sees similar spikes in midterm years.

Based on recent polling, Democrats are expected to regain control of the House of Representatives, though Republicans are seen as having a good chance of maintaining a majority (albeit a slim one) in the Senate. Goldman, citing prediction markets, sees Democrats with a roughly 70% chance of retaking the House, but a less than 40% chance of regaining a majority in the Senate.

Questions over how the election will go, and what impact the new legislative makeup could have on policy, may prevent the market from making decisive moves in either direction over the coming months.

“U.S. equities typically trade sideways during this [pre-midterm] period but rally around the election as uncertainty fades,” the investment bank wrote to clients. However, it added that “high uncertainty” could “make it difficult for investors to take specific election-based views.”

Goldman said it was difficult to determine what impact a divided government could have on stock prices. It speculated that initiatives with bipartisan appeal—including legislation on infrastructure spending and drug prices—could get some traction, although it added that “any compromise under a divided Congress could be difficult.” This would lead “to a reduction of policy influence on share prices,” it wrote, although that wouldn’t mean that Washington stops having an impact on Wall Street. On the contrary, Goldman wrote there was a high likelihood that “a divided government leads to an increase in congressional investigations.”

Investigations are seen as a risk factor for stocks, similar to Mueller’s probe. Stocks have already seen volatility from this kind of news, though the impact has proved short-lived.

Historically, there’s little correlation between how a midterm election goes, and how stocks perform over the subsequent months.

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