President Donald Trump's self-described "report card" for his administration's achievements, a near 30% gain for the U.S stocks since his surprise election win in 2016, could be on the line Tuesday as voters head to the polls in one of the tightest midterm races in recent memory.
Trump has often boasted that his "American First" policies have delivered stronger-than-expected growth, decades-low unemployment rates and record high stock markets, and used his frequent appearances on this season's campaign trail to warn voters that Democrats would take a "wrecking ball" to the economy. Market expectations for Tuesday's result, however, suggest a mixed interpretation for what may come in terms of trade, tax and spending policies, resulting in an equally uncertain outlook for U.S. stocks regardless of who gains control of Congress as of next year.
"Donald Trump's first two years as President have seen a big win for him on tax reform, but a defeat on healthcare. He is fully immersed in trade right now and can also celebrate a strong jobs market, but he has made little progress on his infrastructure spending plan," wrote ING analysts. "Trade and infrastructure plus further tax and healthcare reform are likely to be his key policy thrusts in the second half of his term, but he will need support from Congress. This underlines the significance of these mid-term elections."
The election forecasting website FiveThirtyEight.com suggests that Democrats have an 85% chance of recapturing control of the House of Representatives, while their Republican rivals have similar odds of holding onto the Senate.
That result, based on historic data, would likely deliver slower stock market gains over the final two years of Trump's first term, following a 28% gain for the S&P 500 since his November 2016 election -- the best performance since Dwight D. Eisenhower in the mid-1950s.
ING argues that a split Congress would lessen the chances for further fiscal stimulus, and leave Trump with little choice but to rely on executive orders to advance his trade policies, leaving them susceptible to reversal in the House.
However, the bank also suggests that while a surprise Republican sweep -- which can't be ruled out given the surge in early voting and reports of swelling voter turnout -- would power equity markets in the short term, the concurrent gains would boost the U.S. dollar, slow export growth and quicken the pace of Federal Reserve rate hikes, all of which would pressure equities into 2019's second half.
The S&P 500 has gained, on average, around 17% on a price basis in the year following every congressional election since the Second World War, and only fell on three occasions -- 1974, 1992 and 2002 -- during the same time frame.
However, according to data from foreign exchange trading firm FXTM Group, a Republican president and a split Congress have produced a 15.7% total return for the S&P 500 on average over the past seven decades in the year that follows a midterm election.
"Investors may find that a gridlock produces more predictable political outcomes to model and value equities against," said FXTM's chief market strategist Hussein Sayed. "In the case of a gridlock, Democrats cannot roll back recent tax cuts, neither they can tighten the Dodd-Frank banking rules. It may just mean that Trump will face more difficulties in passing new laws."
In terms of single policy developments that are likely to move markets in the immediate term, the fate of Trump's long-delayed $1.5 trillion infrastructure plan could be the most significant, although the nature of its funding it more likely to dictate its ultimate impact.
"Democrats have talked about an infrastructure program," said UK stockbrokers Rathbones. "But despite the large economic gains possible from improving infrastructure, markets will not want to see it funded by a much higher corporate tax rate."
Trade policy, of course, is likely to be the first order of business for lawmakers, regardless of who takes control of the House from next year, as Congress will need to both approve Trump's recently agreed revision of NAFTA and support or reject whatever decision he takes after meeting with Chinese President Xi Jinping later this month at the G-20 Summit in Argentina.
However, again, the direction of trade policy might not be as binary as assumed if Democrats are able to wrest control of the House.
"Democrats have a history of being more protectionist and may well back the President to some degree on his attitude toward China," ING argued. "They are likely to advocate a softer approach to US allies such as Canada, Mexico and the EU though."