Red ripple Red ripple\images\insights\article\water-ripple-red-small.jpg November 21 2022 November 11 2022

Red ripple

Republicans fail to achieve expected midterm election gains.

Published November 11 2022
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Bottom line 

While it may be several more weeks before we know who won and lost in the Congressional midterm elections, one conclusion is already abundantly clear: the Republican’s widely expected Red Wave failed to materialize. Despite dismal approval ratings, President Joe Biden led Democrats to better-than-expected results in both the Senate and the House of Representatives. With three Senate and 26 House seats undecided, the Democrats could manage to maintain majority control in Washington.

Where do we stand now?

House of Representatives Going into the elections, Democrats held a nine-seat lead with two open seats (221 Democrats versus 212 Republicans). At present, Republicans hold a 13-seat lead, with 26 undecided. The Republicans flipped 22 seats for a total of 211, while the Democrats flipped 13 seats for a total of 198—a net pickup of nine seats for the Republicans. The winning party needs 218 seats for majority.

Senate Going into the midterms, the Senate was split 50-50, with Vice President Kamala Harris voting to break any ties. Although Democrats flipped a seat in Pennsylvania, at the time of this writing, the GOP leads 49 to 48 with three contests undecided. Two may not be called until next week:  Arizona (Democratic incumbent Mark Kelly leads), Nevada (Republican challenger Adam Laxalt leads). The other won’t be decided until December at the earliest. On Dec. 6, and for the second consecutive election cycle, Georgia will hold a runoff because neither incumbent Democratic Raphael Warnock nor Republican challenger Hershel Walker amassed 50% of the vote. In theory, Walker should have an edge, as a libertarian candidate with 2% of the vote drops out. But Republicans were favored to win both Senate runoffs two years ago, yet fell to Democratic challengers. The stars were aligned for Republicans—what happened?

To be sure, it’s been a difficult two years for Biden and the Democrats:

  • Inflation soaring Nominal CPI inflation spiked from 1.4% year-over-year (y/y) when Biden took office in January 2021 to a 41-year high of 9.1% in June 2022, sparked by a doubling of gas prices to $5 per gallon, surging food costs, record high prices for homes and apartments and a more than doubling of mortgage rates to a 20-year high of 7%.
  • Southern border with Mexico is a sieve More than 2.8 million illegal immigrants have crossed in the past year.
  • Violent crime is surging Major U.S. cities (such as New York, Chicago, Los Angeles and San Francisco) have adopted soft-on-crime policies such as defund the police and the elimination of cash bail.
  • Misguided energy policy Misuse of the Strategic Petroleum Reserve for political reasons, and negotiations with Saudi Arabia, Iran, Russia, and Venezuela for more oil, rather than encouraging more domestic production.
  • Withdrawal from Afghanistan Billions of dollars of military weapons abandoned for the Taliban, 15 American soldiers killed and thousands of our Afghan allies left stranded.

Republicans had hoped to make the midterm election an economic referendum on Biden’s first two years in office. In the post-war era, first-term Democratic presidents have lost an average of 38 House seats and five Senate seats in their first midterm election, and Biden’s dismal 43% job-approval rating is down 15% since he took office. Moreover, 33 existing House Democrats chose not to run for re-election. (An open seat is much easier to flip than an incumbent seat.) 

Successful counterpunch for Democrats This should have been a slam dunk for the Republicans. But the Democrats did a masterful job of shifting the political debate to a choice between the social-policy agendas of the two parties, rather than focus on the pocketbook and kitchen-table issues that favored the Republicans:

  • Roe v. Wade Democrats brilliantly used the Supreme Court’s Dobbs decision last June, which returned the constitutional right to an abortion back to each state, to invigorate its base.
  • 'Threat to democracy' From the prime time Capitol insurrection hearings to the well-publicized FBI document raid on former President Trump’s home in Mar-a-Lago, Democrats cast the elections as a referendum on the nation’s fundamental democratic system.
  • Climate change Dems elevated Hurricane Ian’s tragic destruction and loss of life in Florida as a product of the world moving too slowly to counter global warming.

Financial markets already voted Investors rendered their assessment of the Biden administration’s fiscal policies in 2022:

  • S&P 500 plunged 27.5% from its Jan. 4 peak to its Oct. 13 trough
  • Benchmark 10-year Treasury yields soared from 1.50% in January to 4.25% in November
  • Two-year Treasury yields surged from 0.75% in January to 4.80% in November
  • Inversion of 55 basis points between 2- and 10-year Treasury yields implies a growing risk of recession over the next two years

But the S&P 500 rallied 12% from Oct. 13 into Election Day, which in retrospect was an overly optimistic assessment of an expected Republican sweep, the prospect of divided government and the creation of a successful legislative check-and-balance on Biden’s fiscal policies. 

The day after the election, when it was apparent Republicans had not fared well and that the Democrats might maintain consolidated legislative power in Washington for the next two years, the S&P fell 2%.

Leadership change for Democrats? Although he clearly outperformed his low approval ratings in the midterms, Biden may have still lost at least lost the House (and maybe the Senate) when the dust settles a month from now, which likely means his legislative agenda is dead. Democrats may look for new blood and younger leadership in 2024.

Not a good night for Trump Due to poor performances in the high-profile Senate races of Mehmet Oz in Pennsylvania, Blake Masters in Arizona, Don Bolduc in New Hampshire, and Hershel Walker in Georgia, among others, voters rejected former President Trump’s influence with these hand-picked candidates. In fact, exit polls suggest these essentially may have been anti-Trump votes. Logically, that should eliminate Trump’s chances to successfully run again in 2024. 

Great one for DeSantis Florida Governor Ron DeSantis enjoyed a powerful re-election victory, establishing himself as the early front runner to be the Republican standard bearer in 2024.

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Consumer Price Index (CPI): A measure of inflation at the retail level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

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