As widely expected, the Republicans notched a strong win in the midterm elections over the Democrats to take control of the U.S. Senate. Republicans have won a majority in both chambers of Congress for the first time since 2006. Held at the mid-point of a president’s four-year tenure, this midterm election result shifts much of the power away from President Barack Obama.
Many experts have identified sectors such as the energy, medical devices, defense and housing to reap benefits from a Republican win. Historical data also show that equities tend to move up post-midterm elections, irrespective of who wins. Moreover, the trend also coincides with the seasonal gains that markets witness during November-through-April period.
It is highly unlikely that markets will buck the trend this time. Markets have defied the historically weak May-Oct period as Bulls dominated. The seasonally strong period and the Republican win now should bolster stocks and give investors more chances to realize earnings.
Midterm Elections Get Best-Six Month Seasonal Bonus
As already mentioned, the Republican win comes as a bonus during a period which has been historically strong. The trend is popularly known to be ‘Trend of Sell in May and Come Back on St. Leger Day.’ The 2014 Stock Trader’s Almanac reported that S&P 500 has added 1,663 points during November and April between 1950 and 2012. It also reported that while Dow has added 16,398 points during November to April.
Separately, Standard & Poor’s Capital IQ Chief Equity Strategist Sam Stovall notes that since the Second World War, the S&P 500 has added an average of 7% from November through April. However, he also mentioned that the S&P 500 has lost 1.6% on average in the May to October period during midterm election years.
Midterm election years thankfully add extra gains to the seasonally strong period. Chief equity strategist from Bank of Montreal notes that stocks have returned 16.3% during the stated period in midterm election years. Credit Suisse notes that since 1930 during 21 midterm election years, the S&P 500 has jumped 7.4% in the next 100 days following the election day. This shoots up to an average of 17.8% by the end of the year following the elections.
Republican Congress & Democratic President: Best Combination
Republican’s win has also provided us the historically proven best-case scenario of having Republican Congress and Democratic President.
According to a study by Standard & Poor’s Equity Research, S&P 500 has gained 6% on average since 1901 in years when a president had to work with a split Congress. It increases to 6.2% when the president had to work with a unified Congress controlled by the opposition. This is the scenario we will have next year. Moreover, the combination of a Republican-led House and Senate with a Democratic president has led S&P 500 8.6% higher annually.
To begin with the macroeconomic view, a total gridlock disappears. The GOP’s policy chairman and Senator John Barrasso noted that the gridlock will end as Republicans will control both chambers. House Majority Leader of the United States House of Representatives and the U.S. Representative for California’s 23rd District, Kevin McCarthy, also said that the chambers will work together for “one agenda.”
The gridlock has prevailed since 2010 when the Republicans won a majority of the House. On Sunday, Republicans had vowed to cease the legislative stalemate that threatened Washington in recent years. They had promised to pass tax, trade and immigration bills and were hopeful of getting them approved by President Obama.
Sectors Likely to Gain
Republicans winning both chambers now should help clear many of the bills. Keystone XL oil pipelines and Defense Department spending, for example, are expected to move on lines that should benefit the respective sectors.
Starting with the energy sector, the biggest development expected is the end of the impasse over the Keystone Pipeline. A Republican win now is likely to expand the pipeline connecting Canadian oil sands and Gulf of Mexico. There already exists busy trade between the Western Canadian Select (WCS) hub and the U.S. Gulf Coast.
The Republicans, along with a cross section of Democrats, had been pushing for approval of the pipeline which they feel would pump the U.S. economy with multi-millions in revenues. They also advocated that the pipeline would drag down U.S. energy costs and trim the energy import bill.
Among the companies likely to see gains, Texas-based Valero Energy Corp. (VLO) is slated to benefit immensely as a key customer of the Keystone XL Pipeline. Our bullishness stems from the company’s refiners in the Gulf which would see its margins skyrocket once the tide of crude is shifted to Canada from more expensive overseas sources.
ExxonMobil Corp. (XOM) is another stock likely to gain. The energy giant’s significant refining presence in the Gulf stands to clock northward margins once the flow of Canadian sour crude rises. ExxonMobil also holds an approximately 70% stake in Canadian oil sands producer Imperial Oil (IMO).
Also, domestic natural gas producers are also likely to surge as Republicans may ease restrictions on the export of liquid natural gas. Subsequently, natural gas prices are expected to go up, thereby increasing demand for alternative natural gas sources like coal. Peabody Energy Corp. (BTU), Alpha Natural Resources, Inc. (ANR), Arch Coal Inc. (ACI) and Cliffs Natural Resources Inc. (CLF) should be among the ones to gain from this.
All these stocks carry a Zacks Rank #3 (Hold).
Aerospace Defense Sector
Separately, the new Congress may end the sequester cuts in defense spending. The aerospace and defense sector has been up against an apathetic market as military budgets remain under pressure in the U.S. thanks to sequestration. The sequester that went into effect at the start of Mar 2013 will cut spending by a total of approximately $1.1 trillion over the eight-year period from 2013 to 2021. This is bound to affect the sector’s 2014 top and bottom line.
In a bill passed in Jul 2014, the defense subcommittee of the Senate Appropriations Committee provided $549.3 billion to the Department of Defense for fiscal year 2015. The appropriation includes both the base budget as well as the Overseas Contingency Operations (OCO) fund. This compares unfavorably with $572 billion enacted in fiscal year 2014 and $550.7 billion in the President’s budget request.
Republicans are attracted to higher defense spending by the federal government. This would bring immediate gains for industrial behemoths like The Boeing Company (BA), General Dynamics Corp. (GD) and Lockheed Martin Corp. (LMT). While Boeing and General Dynamics currently carry a Zacks Rank #2 (Buy), Lockheed Martin has a Zacks Rank #3.
Medical Devices Sector
The medical devices industry has been subject to the controversial 2.3% medical device excise tax since its enactment beginning 2013. Sequestration-related spending cuts have also undermined the medical devices industry’s prospects.
Medical device taxes have been a very unpopular part of Obama’s Affordable Care Act. Republicans may now revoke this tax, much to the delight of medical devices firms. So medical devices companies including the likes of Medtronic, Inc. (MDT), Abaxis, Inc. (ABAX), Boston Scientific Corp. (BSX), Quidel Corp. (QDEL) and NuVasive, Inc. (NUVA) should benefit.
Abaxis, Boston Scientific, Quidel and NuVasive currently have a Zacks Rank #2, while Medtronic has a Zacks Rank #3.
Budget at Stake?
What is interesting to see now is what happens to the budget extension. The government has funding til mid-December and the Congress therefore must extend it. Republican Senator Ted Cruz of Texas might be eying a short-term extension, though.
A clash over budget once more would seriously hurt the country’s business. However, Republicans would not want a tiff with White House right away, and a budget til mid-September 2015 is desirable. Whatever it turns out to be, both Republicans and Democrats would like to show their accomplishments in the run up to the 2016 presidential elections.
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