Amada Agati:  

In this edition of "Adding Alpha," we take a quick look at the current political environment and make some assessments about what may lie ahead for the midterm elections, as well as any potential impact on markets.

The party controlling the White House almost always loses House seats in midterm elections.

In the past 50 years, the only time this did not happen was the George W. Bush midterms, right after 9/11, in 2002.

President Biden's poor job-approval rating, in the 40s as of this recording, and the current political environment are consistent with Democrats losing control of the House and possibly the Senate, too, although with the recent developments around reproductive rights and privacy issues, it isn't as clear that control of the Senate will ultimately flip to the Republicans.

Those issues can level the playing field a lot in voters' minds this election cycle, in our view.

That said, if the Republicans are successful in taking over the House, it will be especially unwieldy and likely a very early start to the 2024 presidential campaign.

We think this will make meaningful compromises on major legislation pretty unlikely.

If the Republicans pick up 25 or more House seats, Democrats will have low odds of winning the House back in 2024, which makes a Democratic sweep in the 2024 election also highly unlikely.

Even though it doesn't feel like it at all, market performance for 2022 has been remarkably on average with other first-term presidencies.

For years that had a 10% or greater pullback, year two, believe it or not, had an average drawdown of 19%.

And that is exactly what the S&P 500 has experienced so far this year as of this recording.

The year following those large drawdowns delivered a really robust 32% return on average.

What's really interesting is that since 1946, there has never been a third year with negative market returns, with the average result being a strong 15%.

Let's take a look at some visuals.

On the left-hand side of the slide, the chart shows the average annual performance of the S&P 500 going all the way back to 1933, and based on partisan control.

A divided government tends to be the most favorable outcome for the market.

Those two scenarios are at the far left of the slide.

Markets absolutely love gridlock, as it really limits the potential for major or significant negative political surprises.

On the right-hand side of the slide, the table shows select sectors and industries and our views on potential impact, depending on the party in control.

The biggest beneficiaries of a Republican change of control are, no surprise, the defense and oil and gas industries.

But a Republican House or Republican Senate would take the risk of higher corporate taxes off the table, and that's a broad-based positive for all markets.

A Republican Congress would also mean a lot more oversight over regulatory agencies, but at the margin, it actually could mean less aggressive regulation.

Tech, small-cap, and financial-services firms are especially vulnerable to higher tax rates, as well as tougher regulations, so this would actually be good news for them on both of these fronts.

A Republican Congress would also lift several major overhangs from the healthcare sector in regards to concerns around Medicare Advantage reimbursement rate cuts and even prescription drug price controls, resulting in potential tailwinds for the insurance, pharma, and biotech industries at a minimum.

At the end of the day, policy changes can certainly affect markets, but we do not believe a change in control at the midterms this year that results in a more divided government scenario will become an additional headwind for the markets' path forward.

However, as we get closer to the midterms, we will update our thoughts to incorporate any new developments and any new data points in another edition of "Adding Alpha."

So stay tuned.