Stocks for the week ahead: How the medium term could affect Wall Street

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It was a tumultuous week on Wall Street last week, with stocks falling after Federal Reserve Chairman Jerome Powell shattered the market’s dream of a pivot and hinted that a larger rate hike is likely. But Wall Street still pinned its hopes on Washington.

Investors are betting on a big Republican wave in the midterm elections. If Republicans win at least one House of Congress in Tuesday’s midterm elections, that could lead to more gridlock, which markets typically like.

In the nine years since 1948 when Democrats were in the White House and Republicans held majorities in both houses of Congress, the S&P 500 returned an annualized 16.9%, according to Edelman Financial Engines. That compares with 15.1% during the period of full Democratic control and 15.9% during the Republican unity government.

Investors are very happy when politicians bicker but don’t actually enact any new laws that could hurt corporate profits.

An example is the taxation of businesses.

“What does the midterm elections mean for the market? If the Republicans win the House, the tax hike will do nothing,” said David Wagner, a portfolio manager at Aptus Capital Advisors. Republicans may be less likely to approve windfall taxes on oil company profits and generally disapprove of higher taxes on the wealthy.

Markets are also betting that certain industries could get a boost — even if Republicans control the House or Senate and could make it harder for President Biden to pass laws.

That’s because the White House and Republican lawmakers agree in some areas.

“A Republican sweep could lead to more defense spending,” Wagner said. “Increasing the defense budget appears to be a bipartisan issue.” The House passed a record defense budget proposal this summer.

Biden and Republicans also appear to be on the same page when it comes to increasing infrastructure spending. That could boost utilities, construction companies and some real estate stocks. Congress did pass a bipartisan infrastructure bill of more than $1 trillion last year, which, after all, has the backing of President Biden. But it’s not clear what the willingness to increase spending will be…even if there is consensus that more spending is needed.

“Everything is polarized politically, but there is common ground in terms of infrastructure. The same is true [Donald] Trump and [Hillary] Clinton in 2016,” said Jim Lydotes, deputy chief investment officer for equities at Newton Investment Management. “As a country, we underinvested in infrastructure. This is an area where there is a lot of consensus. ”

Of course, there is no guarantee that Biden and other Democratic leaders will be able to work effectively with Republicans in Congress. After all, once the midterm elections are in the rearview mirror, the political narrative will quickly shift to the 2024 presidential race. Congress and the White House are likely to spend more time bickering than trying to pass legislation.

A divided government could also have some major flaws, especially if recession fears materialize next year.

Rob Dent, senior U.S. economist at Nomura Securities International, said the federal government could spend less on social safety net programs if Republicans control Congress.

“All else being equal, this could result in a longer recovery from the recession,” Dent said. That’s more generally negative for stocks as consumer spending drives corporate profits.

Dent added that Washington also risks more squabbling over the debt ceiling, which is unpopular. The last time this was a major issue was during President Barack Obama’s first term. Due to the debt ceiling drama, the US lost its precious perfect AAA credit rating from Standard & Poor’s. After the downgrade in August 2011, the stock market plunged more than 5%.

“This election result is not about what might be done in a downturn, not what might be done to help the economy,” Dent said. “We are concerned that a divided government could lead to brinkmanship on the debt ceiling and the possibility of a government shutdown. We haven’t dealt with this for a while.”

But at the end of the day, political headlines are often just market noise. Ameriprise chief market strategist Anthony Saglimbene said on a conference call last week that stocks have historically risen post-election no matter which party controls the White House and Congress.

The midterm elections could also take a back seat on other macro issues. Saglimbene noted that “growth, profits, inflation and interest rates” are more important to investors in the long run. He acknowledged that the election result could lead to more near-term volatility, but markets were already pricing in the possibility of a split government.

Given that inflation isn’t as transitory as Fed Chairman Jerome Powell predicted for most of 2021, the last thing consumers, investors or the Fed need is politically induced market and economic volatility.

It’s clear that rising commodity and other raw materials, shipping and other transportation costs, and labor costs aren’t going away anytime soon.

Cereal and snack food giant Kellogg’s (K) CEO Steve Cahillane even said on the company’s most recent earnings call last week that the idea that “inflation will be temporary” is clearly always the case. is ridiculous.

We’ll get a better idea of ​​the persistence of inflation on Thursday after the government releases consumer price index (CPI) data for September.

Economists polled by Reuters had forecast overall prices rising 0.7% last month, up from 0.4% in September. That could push prices up year-over-year, up 8.2% in the past 12 months through September, or even higher. Continued strength in the job market will also put more pressure on prices.

“The labor market is resilient and inflation is spreading to the services sector,” said Troy Gayeski, chief investment strategist at FS Investments.

That could lead to more fears that the economy could be headed toward a so-called stagflationary environment, a period in which stagnant growth coincides with high inflation. If that happens, the Fed could keep rates higher for longer.

“We’re finally going to get out of this inflation/stagflation situation,” Gaeyeski said. “But the Fed isn’t going to cut rates to zero anytime soon. That would be very cautious.”

on Monday: China trade data; BioNTech (BNTX), Take-Two (TTWO), Ryanair (RYAAY) and Lyft (LYFT) earnings

Tuesday: US midterm elections; DuPont (DD), Norwegian Cruise Line (NCLH), Lordstown Motors, Disney (DIS), Occidental Petroleum (OXY), News Corp (NWS), IAC (IAC), AMC (AMC) and Novavax (NVAX) income

Wednesday: China inflation data; from DR Horton (DHI), Weibo (WB), Hanesbrands (HBI), Capri Holdings (CPRI), Roblox, SeaWorld (SEAS), Wendy’s (WEN), Redfin (RDFN) and Beyond Meat (BYND ) income

Thursday: US CPI; US weekly jobless claims; earnings for Nio (NIO), Ralph Lauren (RL), Tapestry (TPR), WeWork, Six Flags (SIX), Yeti (YETI) and Warby Parker

Friday: US bond markets closed for Veterans Day; UK GDP; University of Michigan consumer confidence index; SoftBank (SFTBF) earnings

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