What the 2022 midterm election outcome could mean for equities and how investors can benefit from bipartisanship.
If you’ve been listening to political pundits lately, the 2022 midterm election results may seem a foregone conclusion. Republicans appear highly likely to win one or both houses of Congress given Democrats’ narrow control of the legislative branch and President Biden’s declining approval rating amid economic uncertainty.
Whether Republicans prevail or in the unlikely event that Democrats retain control, the implications could be significant for markets and key equity sectors, including tech, health care and industrials. So let’s take a look at the election scenarios and how investors should consider preparing.
From where we sit today, the midterms appear likely to break in favor of Republicans in one or both chambers. Here’s why:
- History doesn’t always favor the political party in power. Going back to 1922, the party of the sitting president has lost, on average, 30 seats in the House and four in the Senate in midterms. Even if Democrats perform better than the historical averages would suggest, their narrow control of both chambers of Congress means they could still easily lose both bodies.
- President Biden’s approval rating has fallen from 56% at the start of his term to below 40% in May, the lowest of his presidency. This is important because presidential approval ratings are often seen as referendums on down-ballot candidates in the president’s party.
- Economic uncertainty may impact voter preferences. In their midyear economic outlook, Morgan Stanley's research team forecasts 2022 GDP growth slowing to 2.6%, from 5.7% in 2021. That combined with inflation reaching multidecade highs and tightening financial conditions, could create significant headwinds for Democratic incumbents.
If Republicans win one or both chambers, investors may want to brace for more gridlock—whether between a GOP-controlled legislative branch and a Democratic White House or within a split Congress. Such divided-government scenarios could make it harder to implement major spending initiatives or policy changes over the next two years.
Of course, a lot can happen between now and election day. As my colleagues in Morgan Stanley Research recently noted, when planning ahead, investors should leave room for scenarios that go against current consensus—in this case, the unlikely event that Democrats retain control of Congress. If that comes to pass, it would create the smoothest path to legislation likely to impact the broader U.S. equity market, such as additional fiscal stimulus.
The likely result: a more divided government and increased gridlock between the legislative and executive branches.
Even in a more divided government, there could be room for bipartisan cooperation on a number of key policy priorities, with the potential to create new opportunities and risks for investors over the next two years or more. My team and I in Morgan Stanley’s Global Investment Office suggest watching these four areas, in particular:
- Increased defense spending: Look for bipartisan agreement on potential hikes in federal military spending, as the U.S. seeks to catch up with foreign adversaries. From 2000 to 2020, China boosted annual defense spending by 513%, while U.S. spending rose just 64%, spurring the Biden administration to cite Chinese military growth as a new benchmark for future U.S. military spending. Watch the performance of U.S. aerospace and defense stocks, which have a strong positive correlation with U.S. defense outlays.
- Robust cybersecurity investment: A dramatic ramp-up in cybersecurity threats from abroad, including China, Russia and North Korea, is heightening U.S. government vigilance. Morgan Stanley expects federal spending on cybersecurity to increase over time as cyber-related threats mount, creating a bullish environment for cybersecurity stock valuations.
- Supply-chain “reshoring”: Concerns about inflation-fueling supply disruptions are adding momentum to a broader trend of returning, or “reshoring,” manufacturing to the U.S. Federal efforts to strengthen domestic production are expected to grow. In 2022 and 2023 alone, Morgan Stanley researchers expects capital investment in U.S. factories to increase 7.5%. U.S. semiconductor companies, in particular, could benefit from federal legislation that would incentivize more manufacturing at home.
- Prescription drug-price reform: The rising number of Medicare enrollees and continued negative sentiment surrounding out-of-pocket drug costs have put the issue of drug-price reform in the spotlight recently. Though potential reforms are currently driven by Democrats, politicians on both sides of the aisle could potentially push for legislation to curb drug prices, which could pressure the valuations of pharmaceutical stocks. Despite these potential headwinds, pharmaceutical earnings multiples are near their lowest level since 1990 relative to the S&P 500 Index, and we believe the sector’s relative cheapness could create buying opportunities among select names.
Find out more in Morgan Stanley’s report “US Policy Pulse, 2022 Midterm Preview: Changing Horse Midstream.” Or listen to a short audio version of this report. Your Morgan Stanley Financial Advisor can help you understand how you may want to position your portfolio for a new policymaking environment.
- If the federal government becomes more politically divided following the 2022 midterm elections, how could it affect the equity market and my portfolio?
- Could bipartisan cooperation on key policy priorities create investment opportunities that align with my long-term financial goals?