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RED WAVE, BLUE WAVE: What could happen to markets if Republicans win big or lose big on Tuesday

“Historically stocks have thrived in gridlock,” said Joseph Song, U.S. economist at Bank of America Merrill Lynch. “Under a Republican president, a split Congress has been the best outcome, yielding 12 percent average annual returns for the S&P 500.”

Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, said in a note the market has been expecting this scenario and clarity on this front will be bullish.

“Equity investors have been expecting a split Congress,” she said, noting few believe “a sweep by either party is probable.”

The potential for impeachment: House Minority Leader Nancy Pelosi — the favorite to become speaker in a Democratic House — and other Democratic leaders have so far sworn off talk of impeaching President Donald Trump in order to avoid stoking fury in the Republican base. But if their investigations into the administration or special counsel Robert Mueller‘s Russia probe reveal new information, Democrats could pursue it more aggressively.

Even the higher possibility of a Trump impeachment could spark more market volatility.

“If impeachment proceedings are considered, as they might be today, this would represent a macro ‘shock,'” Song said. “The market has generally recovered much of the initial sell-off from historical shocks, in many cases due to central bank policy responses. In today’s case, one key risk under potential impeachment would be that of reversing tax reform, which has contributed double digit earnings growth to S&P 500 companies.”

Still, even if the House impeaches Trump, a GOP-controlled Senate likely will not vote to remove him from office.

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The war over health care: On the policy front, Democrats and Republicans may struggle to find common ground. Both parties, including Trump, have stressed the need for an infrastructure overhaul. But since Trump became president, lawmakers have struggled to reach a consensus on exactly what an infrastructure plan would look like and how it would be funded. The situation may not change with split control.

On health care, Democrats want to shore up the Affordable Care Act to curb rising premiums — and some want to take even more action to expand the government’s role in health care. They may not find common ground with Senate Republicans. Senate Majority Leader Mitch McConnell has said the GOP could move again to repeal Obamacare if it gains enough Senate seats.

Impact on Big Pharma: While Trump recently unveiled a proposal intended to cut Medicare drug prices, he has shied away from his campaign promise to allow Medicare to negotiate directly with drug companies. Democrats also support that proposal and expressed dismay when Trump appeared to abandon it.

Investors have already priced in a lack of meaningful drug-price reduction legislation being passed, according to David Kostin, chief U.S. equity strategist at Goldman Sachs. The S&P 500 health care sector has climbed more than 7 percent this year and is one of the best performers of 2018.

“The performance of Pharma stocks has tracked the prediction market likelihood of a Democratic victory in the House, suggesting investors believe a divided Congress would reduce the likelihood of major regulatory changes regarding drug pricing,” Kostin said.

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Some stocks that could benefit from this scenario are Celgene, Regeneron Pharmaceuticals and Amgen. Celgene and Regeneron are down for the year, while Amgen is up more than 10 percent for 2018. Kostin included them in Goldman’s Government Exposure basket, which is made up of companies with at least 20 percent revenue exposure to government spending.

Gains for defense: With Trump and the GOP fixated on boosting defense spending, funding for the Pentagon would also likely go up again with divided control of government. Democratsjust agreed to a Defense Department budget increase for fiscal year 2019.

This could give defense stocks a boost after the election. The iShares U.S. Aerospace and Defense ET is up more than 4 percent this year, outperforming the S&P 500.


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