Will the economy drive midterm elections? Will the economy drive midterm elections? http://www.federatedinvestors.com/texPool/static/images/texpool/texpool-logo-amp.png http://www.federatedinvestors.com/texPool/daf\images\insights\article\capitol-building-us-small.jpg October 3 2022 October 3 2022

Will the economy drive midterm elections?

Or will social policy issues keep it close?

Published October 3 2022

Bottom line

One of the biggest questions facing investors today is whether the critically important midterm elections on Nov. 8 will serve as an economic referendum on President Biden’s first two years in office. Historically, the party out of power gains seats in a new president’s first midterm election, and Biden’s poll numbers have been decidedly under water on the merits. 

The U.S. economy is grappling with the worst inflation in four decades, which the Federal Reserve believes is at least partially due to some of President Biden’s fiscal policies. To combat this surge in inflation, it has increased the fed funds target range aggressively over the last five policy-setting meetings. It now sits at 3-3.25% (up from 0-0.25% six months ago), collectively the Fed’s most rapid pace since Paul Volker was chair in the 1980s. Consequently, the economy appears to be on a glide path into recession, and the S&P 500 has plunged 25% so far this year. This steepest decline to start a year since 2008 has taken it to a depth we have not seen since the presidential election in November 2020. 

Typically, this would be a slam dunk for massive Republican gains in the upcoming midterms. But Democrats have done a masterful job of shifting the political debate away from pocketbook issues like the rising cost of food, gas and housing. Instead, they have successfully pivoted voters to consider a series of hot-button social policy issues right in their wheelhouse. As a result, what looked like an impending red tsunami earlier this year has narrowed considerably in recent months, and Democrats believe that they may hold onto their slim majorities in both the Senate and the House of Representatives. 

Handicapping the House of Representatives Voters split their ballots significantly in 2020. While they elected President Biden, they also attempted to craft a legislative check-and-balance, which reduced the Democrats’ lead in the House from 35 seats in 2020 to only nine today. At the same time, the 2020 decennial census awarded Republicans a net gain of six seats in the upcoming 2022 elections due to the subsequent Congressional redistricting. There was a massive population migration in the U.S. over the past decade, as millions of Americans left high-tax states like California, Illinois, and New York to relocate in low-tax states like Texas, Florida and North Carolina. 

In the post-war history of the U.S., Democratic presidents lost an average of 38 House seats in their first midterm election. Moreover, 33 current Democratic members of Congress have chosen not to run for re-election in six weeks. An open seat is much easier for the Republicans to potentially reclaim than an incumbent one and vice versa. President Clinton, for example, lost 52 seats in his first midterm election, and President Obama gave up 63. President Biden views himself as a modern-day Lyndon Baines Johnson, with President Johnson’s passage of his Great Society social policy initiatives. But LBJ lost 47 seats in his first midterm election. 

Handicapping the Senate The Democrats have a much better chance of holding their slim majority in the Senate, which is currently split 50-50, with Vice President Harris breaking all ties. In the November 2022 midterms, 35 Senate seats are up for grabs, but Republicans are defending seven more seats (21 versus 14). Moreover, five Republican Senators have already announced their retirement. 

Biden’s polls are poor but improving According to Real Clear Politics, Biden’s job approval rating is now 43%, 10 percentage points lower than his disapproval rating of 53% and 15 percentage points lower than when he took office in January 2021. But it represents a 6% improvement from his poor 37% approval rating in July. Biden’s approval ratings specifically on the economy and foreign policy are a dismal 38% and 40%, respectively.

As independents vote, so goes the election Independents are the largest block of voters in the country at 36% of the total, compared with 31% for each of Democrats and Republicans. 

  • Democrats have an 86% approval rating for President Biden, up from 78% in July, but down from 98% since January 2021.
  • Republicans have a 7% approval rating for Biden, up from 3% in June, but down from 11% in January 2021.
  • Independents have a 39% approval rating for Biden, up from 31% in July, but down from 61% in January 2021.

Direction of the country Nearly 65% of voters believe the U.S. is headed in the wrong direction compared with 28% who have a favorable view. But that’s significantly better than July results, which were at 77% wrong versus 13% right. 

What are the key issues?

Republicans are focusing their attention on several important pocketbook and kitchen-table issues:

  • Stronger economy and lower inflation, with a focus on restoring traditional energy production versus renewables.
  • Safety, as crime is surging in cities and the southern border is a sieve. They want a better immigration policy and to hire 200,000 more police officers instead of 87,000 IRS agents.
  • Education, in particular improving underperforming schools and getting kids back on track from the ground lost during the pandemic.
  • Foreign policy, as the botched Afghanistan withdrawal was the first domino to fall, with the Russian invasion of Ukraine, the Iranian nuclear deal and the Saudi oil situation soon to follow.

Democrats have successfully pivoted their supporters to focus on social policy issues including:

  • The Supreme Court’s Dobbs decision that overturned Roe v. Wade.
  • President Trump’s perceived threat to democracy. 
  • Climate change.

Global shift to the right? In recent months, we have seen other democracies shift to new right-of-center leaders:

  • Liz Truss: new U.K. prime minister and the leader of the Conservative Party.
  • Giorgia Meloni: leader of the right-wing Brothers of Italy party and expected to become Italy’s first female prime minister.
  • Jimmie Akesson: New leader of the far-right Sweden Democrats. 

Gridlock is good for the markets Republicans should win a tighter-than-expected race in the House, while the Senate looks like a coin flip. However, even a narrow Republican victory in the House will re-introduce divided government in Washington, and the stock market historically has loved gridlock. While the S&P’s sharp 25% correction so far this year reflects investor frustration with the state of the economy, stock prices typically rally during the fourth quarter of midterm election years if voters introduce divided government. The market risk is that if the Democrats should manage to keep both houses of Congress in the midterms, and there is no change in the current direction of our fiscal policy, then there may no change in direction for stock prices either.

Connect with Phil on LinkedIn

Tags Equity .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Federated Advisory Services Company

977761039