How the Midterm Elections Will Impact the Markets

Now that the Georgia Senate runoff election has come to a close, we finally have some clarity into what the political landscape looks like following the U.S. midterm elections. Now the question becomes, how will the results impact the markets? In this episode of The Agent of Wealth Podcast, host Marc Bautis goes over the key takeaways from the election, possible policy changes to look out for and shares his predictions for how it will all impact the markets – and, in turn, your portfolio.

In this episode, you will learn:

Key takeaways from the 2022 midterm elections.
How the 2022 midterm election outcomes will affect bi-partisan, Democrat and Republican policies.
What you need to know about The SECURE Acts.
How markets historically react to election years.
Predictions for the markets following the 2022 midterm elections.
And more!

Resources:

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Welcome back to The Agent of Wealth Podcast, this is your host Marc Bautis. With the Georgia Senate runoff finishing last week, we now have some clarity into what the political landscape looks like post midterm elections.

Key Takeaways From the 2022 Midterm Elections

To summarize what happened, Republicans won control of the House of Representatives while Democrats have expanded their majority in the Senate. Historically, the expectation heading into the midterm election is that the political party out of power will do well, and that didn’t necessarily happen this year. There wasn’t a “red wave,” as a lot of people were expecting.

The Senate

The Senate tilted 51 to 49 in favor of Democrats (the Democrats gained one seat in the midterms). However, since the midterm election, Kristin Sinema, an Arizona Democrat senator, announced that she’s changing her affiliation to be registered as an Independent. It remains to be seen what this means to the way she votes.

West Virginia Senator Joe Manchin, who became famous over the past couple of years for blocking certain Democratic-sponsored legislation from passing, has announced he isn’t planning to change affiliations, but left the door open to do so in the future.

The House

On the House side, it looks like Republicans will have 222 seats as compared to 212 Democrat seats. There’s still one seat left, which will have a special runoff. But this is an increase of 10 seats for Republicans – and 218 is the magic number to have a majority

How 2022 Midterm Election Outcomes Will Affect Policy

As for policy, these results likely mean we’re going to see gridlock for at least two more years. That likely means there will be no tax increases, and no large progressive spending packages will gain enough votes for approval.

Just this week, I was asked about some of the provisions in the Build Back Better Plan, which was proposed toward the end of 2021 by President Biden. The questions I received were mainly around the elimination of the step up of basis in an assets cost basis when someone dies, and also how some capital gains could be taxed prior to realizing the gains. Right now, if you have gains in a house, stock or real estate investment, you’re not actually taxed on those until they’re sold. In the Build Back Better Plan, there were some provisions that changed that, and you technically could be taxed even if you didn’t sell the asset.

The Build Back Better Plan also included expanded social spending, corporate and individual tax increases, additional clean energy investments and subsidies, and raising or eliminating the cap on state and local income tax deductions.

With Republicans taking control of the House, the Build Back Better Plan probably won’t pass – at least not in its current form. Instead, Republicans will probably try to pass bills focused on taxes, energy independence, strengthening the supply chain and cracking down on illegal immigration. But, because Republicans don’t have control of the Senate or the President’s veto power, these bills likely won’t pass. Instead, they will function to shape the message for the party leading up to the 2024 Presidential Election.

Democrats will likely be focused on confirming President Biden’s nominees, especially for judicial appointments – which last beyond the duration of a President’s term.

Recently, we’ve seen a lot of policies decided in the courts, some going as high as The Supreme Court. For example, The Supreme Court is going to hear the challenge to President Biden’s Student Loan Debt Relief Plan. For these reasons, nominees to the judicial system remain super important.

Democrats may also want to increase the debt ceiling sometime before next summer.

Even under a divided government, there are certain policies that have a high chance of going through.

We can expect defense spending to rise, because Republicans and Democrats have a shared interest in it – both substantively and politically. Both parties feel that we’re in a more dangerous world, given Russia’s invasion of Ukraine and the eroding relationship between the United States and China.

There’s going to be a competition to be “tougher on China” as we head towards 2024. This may lead to political incentives aligning both sides to push new measures on export controls and restrictions. There may also be some restrictions put on outbound investment.

Tax cuts for the middle class could result in a compromise deal, because President Biden and the Democrats may not want to be seen as opposing tax relief for everyday people. It may even involve an initial veto from President Biden to excise possible tax cuts for “the rich” from any GOP package.

Another area of possible bipartisan cooperation is around SECURE Act 2.0, which would implement reforms around retirement savings.

What You Need to Know About The SECURE Acts

The SECURE Act (1) is a piece of 2019 that has been passed. It added some important new enhancements to existing rules about retirement saving, including:

Raising the age of required minimum distributions (RMDs) from 70 ½ to 72. Delaying your RMD gives you more time to adjust to what your work and tax situation might be, retire a little bit later, and, when the taxable distribution is required, potentially be in a lower tax bracket.
Eliminating an age limit for traditional IRA contributions. They can now occur at any age, provided the individual has earned compensation. Previously, they had a stop at 70 ½.
Removing the ability of non-spouse beneficiaries to “stretch out” distributions from an inherited IRA over their lifetimes. In these circumstances, the entire value of the inherited IRA must be distributed within ten years of its receipt. (Those who inherited an IRA before the SECURE Act took effect are grandfathered in and may continue to stretch out their RMDs.)
Allowing 529 college savings plan account holders to use funds in their plan to repay up to $10,000 per year in qualified student loan debt.
Access to penalty-free withdrawals of up to $5,000 per year from a workplace savings plan (such as a 401(k)) to help offset the costs of having or adopting a child.

Here’s what’s included so far in The SECURE Act 2.0 provision, which is a proposal that hasn’t yet been passed. But again, it may get bipartisan support in 2023:

Updates to RMD’s. Instead of having to take RMDs starting at age 72, they could be delayed until 73, 74 in 2029 and 75 in 2032.
An increase in catch up contributions. Catch up contributions allow people 50+ to contribute additional dollars over the standard maximum contribution amounts to 401k’s and IRA’s.
Auto enrollment in company-sponsored 401k plans. Currently, employers have the option of auto enrolling a worker into their 401k plan, but it could become a standard.

So we’ll see what happens to Secure Act 2.0 in 2023.

Predictions for The Markets

Now, onto the predictions for the markets.

Market volatility is generally higher during the midterm election years, especially in the weeks leading up to an election day. We’ve definitely seen that, although I’m not sure if the midterm elections were the cause of the volatility.

Since 1970, midterm years have had a medium standard deviation of 16%, compared to 13% in other years. That basically means that returns are more volatile in midterm years. Now, the silver lining for investors is that markets have tended to rebound strongly in the subsequent months after the midterm election. Since 1950, the average one-year return of the S&P 500 index following a midterm election has been 15%. That’s more than twice the return on all the other years during similar periods.

Now, of course, every cycle is different and elections are just one of the many factors that influence market returns. But the resolution of the uncertainty surrounding an election can calm investors. I talk about this a lot, the fact that the market hates uncertainty. So after an election is complete – no matter who wins, or what the political landscape looks like – uncertainty is gone and investors get calm.

We’ve seen that this year, but again, I don’t know if it’s because of the midterm elections or because it looks like we may have reached peak inflation. But, since the election in November, the markets have had a good run.

Related: When Will We Hit Peak Inflation?

We do believe that it’s probably not just politics that are driving stock performance. How markets react is likely 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, and we take this into account.

When we manage client accounts or portfolios, we look at the US business cycle (or earnings) as 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.

So that wraps up today’s episode. Thank you to everyone who tuned into today’s episode. If you have any questions about the midterm elections, you can email them to me – I’d be happy to discuss with you. Don’t forget to follow The Agent of Wealth on the platform you listen from and leave us a review of the show. We are currently accepting new clients, if you’d like to schedule a 1-on-1 consultation with our advisors, please do so below.

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Episode 134 – How the Midterm Elections Will Impact the Markets