How the US Midterm Elections Could Impact the Stock Market

The midterm elections next week could be a defining moment for equity investors, with most polls pointing to Republicans winning at least the US House and possibly the Senate. This would end Democrats' control of the legislative branch and potentially usher in a period of gridlock.

While a divided government may not be ideal for stocks in general, it can actually help to reduce uncertainty and preserve the status quo. This is especially true in sectors like health, energy and tech, where the makeup of the next Congress will be key to determining their future direction.

Republicans also have a chance of winning the Senate, which would give the GOP full control of Congress and make it easier to advance their policy priorities. However, President Joe Biden could use his veto power to block some of these policies. This could be the best-case scenario for industries that tend to be favored by Republicans, such as energy, defense, pharmaceuticals and biotech.

If Democrats lose control, Biden would have to rely more on executive action to promote his priorities, since he would no longer be able to use lawmakers to execute his agenda.

After the midterm election results are in, equity investors will want to keep an eye on the following areas:

The cannabis industry has been struggling over the past year as US legalization efforts have stalled and investors have become more cautious about investing in the highly speculative sector. The Cannabis Index has fallen 57% in 2022, with Tilray Brands Inc., Canopy Growth Corp. and SNDL Inc. all seeing declines of at least 45%.

Investors will be closely watching several state referendums on legalization at the local level. Voters in Maryland, Arkansas, Missouri, North Dakota and South Dakota will decide whether to approve legalization for adults.

According to Bloomberg Intelligence analyst Kenneth Shea, if four or five states approve of the proposed regulations, it would be considered a positive development. However, if Maryland does not approve, that would be seen as a negative.

If the Republicans maintain control of at least one chamber of Congress, it is unlikely that federal legalization of cannabis will happen in the near future. However, if the Democrats were to gain control of both chambers of Congress, it would be much more favorable for the cannabis industry. Last month, when Biden issued a pardon for all prior federal offenses for simple possession of marijuana, the Cannabis Index surged by 18%.

Investors in the healthcare industry have been closely following developments from Washington around the issue of drug pricing. With the midterm elections looming, the ramifications for the sector are magnified.

The Inflation Reduction Act would allow Medicare to negotiate prices for some drugs, which Democrats say could lower costs for Americans. Not all high-price drugs would be subject to negotiations, but certain cancer treatments and other brand-name medicines used by seniors could have lower prices as early as 2026.

According to Cowen analyst Rick Weissenstein, Republicans have traditionally been more favorable to the drug industry than Democrats. While Republicans won't be able to repeal the drug pricing provisions, they have vowed to hold hearings on the plan and to look for other ways to slow down implementation of the bill.

Any changes to rules on drug pricing could have a big impact on the revenue outlooks for major pharmaceutical companies like Pfizer, AbbVie, Eli Lilly, and Merck. These companies could see their profits take a hit if drug prices are regulated more closely.

The threat of delisting Chinese stocks that trade on US exchanges but don’t comply with Trump-era audit laws has support from both Democrats and Republicans. This, along with growing geopolitical tension surrounding China, has caused the Nasdaq Golden Dragon China Index to plunge 39% this year.

If Republicans take control of Congress, Jaret Seiberg, an analyst at Cowen & Co., believes that the intensity of oversight will increase and that hearings on the status of audits and the listing of Chinese firms in the US may be held.

According to the Securities and Exchange Commission, there are approximately 200 stocks that may be delisted from US exchanges for failing to provide access to their records for American auditors. This includes major tech companies such as Alibaba Group Holding Ltd., Pinduoduo Inc., and Baidu Inc.

After the Democrats passed their landmark climate law, there was speculation about whether the long-term subsidies for clean-power installations would be safe. However, it is now looking unlikely that these credits will be in danger after the midterms, which is good news for companies like NextEra Energy Inc. and Sunrun Inc. With two more years left in his term, Biden is likely to want to protect this signature achievement.

Energy stocks have been one of the few bright spots in an otherwise tough year for the stock market, thanks to soaring oil and natural gas prices. That's led to higher fuel costs for Americans, making the energy sector an easy target for Democrats during an election cycle focused on the burdens caused by inflation.

If Republicans win control of either the Senate or House, it is unlikely that energy policy will see a major shift. While the Biden administration has recently threatened to impose a windfall tax on oil producers, which initially sent companies including Phillips 66, Exxon Mobil Corp. and Chevron Corp. lower, such a proposal is likely to be blocked by Republican lawmakers.

According to Benjamin Salisbury, a managing director at Height Capital Markets, even under the current makeup of Congress, Biden has "little power" to push his tax proposal through. Salisbury added that it is "highly unlikely" that Congress will make any progress on the issue before year-end, and that it is unlikely to address it in 2023.

According to Louis Navellier, the chief investment officer at Navellier & Associates, there is a potential upside for energy stocks if Biden somehow gets the votes he needs to move forward with a windfall tax. The idea is that the levy would discourage new investment, thereby curbing oil supplies and driving prices even higher.

Major US technology companies, from Alphabet Inc. to Meta Platforms Inc., have long been thought to be a target for potential regulation. And indeed, the White House is planning a post-midterms push for antitrust legislation, a last-ditch effort to get a stalled pair of bills through Congress before a predicted Republican takeover in January. The GOP has made it clear that they won't support the bills if they retake control of either chamber of Congress.

For tech investors, the midterms also bring a renewed focus on the research and development tax break that was put in place during the Trump administration. That legislation expired last year, but it allowed firms with large R&D spending, like Intel Corp. and Amazon.com Inc., to fully deduct those costs during the year in which they occurred, instead of having to write them off over a period of five years.

"If the R&D tax credit is reversed, we believe it would be positive for the information technology sector," said Michael Taylor, an analyst at Wells Fargo. "If the tax credit is not reversed, companies in the sector could potentially see a higher corporate tax bill, which could weigh on their earnings and performance."