Midterms Pose Investing Plight: ‘You Can’t Position’ for Events Like This
Investors are cautious after calls on 2016 election, Brexit proved to be wrong
Investors around the U.S. are bracing for the unexpected heading into the midterm elections, wary of being caught wrong footed as many were after the 2016 presidential election, Brexit and other crucial votes over the years.
Few are predicting that the outcome widely seen as most likely—Democrats winning the House and Republicans retaining control of the Senate—will fuel the type of violent price swings that came on the heels of President Trump’s victory.
But many agree the elections could create fresh winners and losers in the market: Manufacturers and construction firms could get a boost if a divided Congress can come to an agreement on infrastructure spending, while banks stand to lose if a Democratic sweep leads to a halt in deregulation.
Investors can take some comfort: History suggests the stock market will fare well no matter who wins on Nov. 6. The S&P 500 has risen in the year after every midterm election since 1946, according to brokerage and advisory firm Strategas. Analysts attributed this to investors redeploying funds kept on the sidelines ahead of elections, as well as the market’s tendency to climb throughout history.
Still, the potential for a shock has investors keeping a close eye on the results as they trickle in late Tuesday and early Wednesday.
“I have a feeling I’m not going to sleep that well that night,” said Ben Phillips, chief investment officer of New York-based EventShares. “Maybe a catnap here and there.”
About two weeks ago, EventShares added shares of Martin Marietta Materials Inc., Granite Construction Inc., United States Steel Corp. and other industrial firms to its U.S. Policy Alpha exchange-traded fund. The wager: Even if leadership in Congress is split, legislators may be able to come to an agreement about boosting infrastructure spending. The firm’s fund also includes banks like BB&T Corp. and Goldman Sachs Group Inc. that could benefit from a looser regulatory environment.
“Our base case is a split Congress,” Mr. Phillips said, adding that the firm will be watching for the opportunity to add or trim positions after the election.
Investors have been less confident in strategies hinging on a pure Republican sweep.
An ETF trading under the ticker “MAGA,” an acronym for Mr. Trump’s “Make America Great Again” campaign slogan, has posted net outflows for six of the past seven months after attracting millions of dollars at the start of the year, according to Lipper. The ETF, whose top holdings include cigarette makers Philip Morris International Inc. and Altria Group Inc., invests in companies whose employees and political-action committees have donated to Republican politicians.
It is down 5.7% this year, while EventShares’ fund—which bets on policy, rather than on political party—has fallen 0.9%. The S&P 500 has risen 1.8%.
Some analysts are advising investors to be wary of fleeting gains.
Regardless of who wins the elections, stocks will likely rise, supported by some removal of uncertainty over the direction of domestic politics, said Lee Ferridge, head of macro strategy for North America at State Street Global Markets in Boston.
But those gains are likely to be short lived, Mr. Ferridge said, adding he has told investors to use any rally as an opportunity to sell stocks. He said he believes markets are likely to turn rocky again before year-end amid rising U.S. bond yields, pricey technology stocks and other issues that have weighed on equities in recent weeks.
“We will have a rally because everyone thinks we will have one,” Mr. Ferridge said. Over the long term, however, “there’s an awful lot of uncertainty out there.”
One group that could take a hit following the elections given a Democratic sweep: bank stocks. Analysts at UBS Global Wealth Management believe a Democratic-led Congress will work to impede recent White House efforts to roll back financial regulation such as the Dodd-Frank Act.
“There’s a wing of the Democrats that views financials less favorably,” said Justin Waring, strategist at UBS Global Wealth Management’s chief investment office in New York. “Markets may not like the change in tone.”
Nevertheless, the firm currently has an “overweight” rating on the sector, believing that low valuations and other factors will override political considerations over the long term.
Other investors say they plan to sit back and watch what unfolds in the following weeks, rather than trying to place bets on the market right away.
When Mr. Trump won the presidential election, U.S. stock futures plunged overnight, at one point hitting the 5% limit that exchanges set to prevent further drops. But by the end of the following day, the Dow Jones Industrial Average had rallied more than 200 points.
“The midterm effect on markets will be quick,” said John Augustine, chief investment officer of Huntington Private Bank in Columbus, Ohio. “Things like the Fed and U.S.-China trade relations—those to us are the focus, and those will be developing over longer periods of time.”
Mr. Augustine added that his firm wasn’t planning to have staff stay on site on the night of the midterms.
If the Republicans end up holding on to their majority in both chambers, Mr. Augustine said he might consider taking on more shares of so-called cyclical sectors: companies whose fortunes tend to closely align with economic growth.
Experts’ poor track record of predicting key votes such as the referendum on Britain’s membership in the European Union and the 2016 U.S. election have made many wary of committing to a particular outcome ahead of time.
“You can’t position yourself for something like this,” said James Bianco, head of Chicago-based advisory firm Bianco Research. “There’s a consensus, but the results have confounded consensus again and again.”
As a rule of thumb, investors should bear in mind that “Trump’s policies are pro-business, and anything impairing that would be negative for the market,” he said.
“Are we living in interesting times? Yes,” he said.