CME: S&P 500ES1!; NYMEX: WTI CL1!and Henry HubNG1!; COMEX: CopperHG1! and AluminumALI1!

The 2020 U.S. presidential election put Democrats in control of the White House and both branches of the Congress. In the upcoming mid-term elections, if Democrats retain their majority, Joe Biden will become the most powerful U.S. president in the 21st century.

Donald Trump, his predecessor, enjoyed a Republican-led Congress in the first two years. However, after Democrats took back the House in 2018, Mr. Trump found himself fighting with Speaker Nancy Pelosi daily, all the way to a presidential impeachment in 2020.

President Obama faced a divided Congress in six of eight years. The only lasting impact of his presidency may be Obamacare, besides his own legacy as the first African American president in U.S. history.

United We Act, Divided We Fight
Looking back on the 90 years since Franklin D. Roosevelt first became president:
• We had Party Government for 44 years. The term refers to where the president, the house and the senate are controlled by the same political party.
• For 14 years, we had a Divided Government, where only one branch of the Congress aligned with the president.
• The remaining 32 years were Opposing Government, where the president and the Congress came from opposing parties.

A divided or an opposing government tends to spend too much time on political infight. It’s difficult to reach a consensus to do big things. Major bills usually got approved in a unified government, and their impact extends far beyond the four-year presidency.

For proof, we only need to look at how government spends money.
In 2022, Medicare is the biggest expense item in the $6 trillion federal budget. Medicare Act was introduced in 1965 under President Johnson and a Democrat-led Congress. More than half a century later, it now costs $1.44 trillion or 24% of government spending.

Social Security is the second largest expense item. The program was enacted in 1935 by a Democrat-led Congress as part of President Roosevelt’s New Deal. Social Security costs $1.13 trillion in 2022, or 19% of federal budget.

Biden Administration’s Achievements
What did the Biden Administration accomplish? One may point out the embarrassing retreat from Afghanistan in 2021 and the runaway inflation in 2022. However, Mr. Biden has been very effective in pushing legislative agenda. In just 1-1/2 years, four major bills with a $4 trillion total budget have been signed into law.

A month after Biden took office, Congress passed a $1.9 trillion American Rescue Act on March 11, 2021. Most Americans received a $1,400 check from the Treasury Department. Millions of small businesses got approved for much needed loans. Government bailout prevented the economy from going into recession in the depths of a pandemic, even though it might have paved the groundwork for hyperinflation we are experiencing now.

On November 15, 2021, Congress passed a $1.2 trillion Infrastructure Investment and Jobs Act. Among the biggest items, $110 billion are allocated to upgrade the country’s roads and bridges, $66 billion to renovate passenger and freight railways, and $65 billion to revamp the electric grid. U.S. unemployment rate stays very low this year, thanks in part to the new jobs created from government funded programs.

On August 9th, Biden signed into law the U.S. Chip and Science Act, which has a $280 billion price tag for ten years. Just a week later, He approved the $737 billion Inflation Reduction Act.

Most economists agree that bill has little chance of reducing inflation. The real purpose is to fund climate programs. To be budget-neutral, high-income earners will see a tax hike. Investment carry interest will be taxed. And there is a 15% minimum corporate tax.

Mid-term Outcomes and their Implications to Financial Market
The 2022 mid-term elections consist of 36 senate races, 435 house races, and 36 gubernatorial elections. There are thousands more at state and local government levels.

Depending on their political leanings, different polling agencies have very different mid-term predictions. Here, I would like to explore the impact of the mid-term elections on financial markets based on the three states of governing:
• A one-party government
• A divided government
• A lame duck government

One-Party Government
The Democrats currently control the Presidency, the House of Representatives, and the Senate. A united government could do big things and spend big money. If Biden’s party win in the midterm, the Administration would continue its path to "Build Back Better ".

The Winners:
• The stock market: My chart shows correlation of market turning and passage of big bills. Government investment creates jobs and supports business expansion. If you expect Democrats to win, you could express this view by a bullish equity index trade. Suggested strategy: Long CME E-Mini S&P 500 Futures.
• Base Metals: Massive infrastructure programs call for more use of industrial materials. This is Bullish for NYMEX Copper and Aluminum.
• Climate programs will provide more subsidies to clean energy, electric car, and new investment to support an ambitious carbon reduction goal.
https://www.tradingview.com/x/2UbBMOmT/

The Losers:
• Fossil energy: Traditional oil and gas industry would face more government restrictions. This is bad for stocks in the energy sector, but Bullish for NYMEX WTI crude oil and Henry Hub natural gas. Less domestic drilling means less energy supply.
• High net-worth investors: Higher tax rate on people earning $400,000 or more. New taxes on investment carry interest. This will be bad for hedge funds, private equity, and venture capital funds.
• The 15% minimum corporate tax will affect multinational corporations and high-tech companies which frequently use offshore tax haven.
• While government spending may help pop up the S&P, the Tech-heavy NASDAQ 100 may be a loser with the higher corporate tax rates.

I am concerned about the long-term ramifications of the new taxes on innovations. Government investment could not replace the role of venture capital. The former tends to be risk-adverse and the latter has more risk appetite to fund early-stage companies. They may find ten losers before running into a blockbuster. If you cut off the incentive by taxing the winner, venture capitalists will no longer fund the Apple or Google of tomorrow.

Divided Government
If Republican retakes either the House or the Senate, but not both, the Administration would face challenges mainly in government spending and taxes. New legislation may be stalled at a Republican-led House or Senate.

I don’t see any clear winners or losers in this scenario. The Administration would turn its focus on implementing the bills already passed, such as the CHIP Act and the Inflation Reduction Act. Fewer new legislations are on the horizon.

Lame Duck Government
If Democrats lose control of both the House and the Senate, we may well expect a lame duck government in the next two years. A Republican-led Congress would launch attack on “Build Back Better” and roll back progressive policies enacted by the Democrats.

The Winners:
• Oil and gas. Domestic drilling will resume in full speed.
• The rich. New taxes will be rolled back.

The Losers:
• Climate programs. Funding will be stripped out or watered down.
• New energy and electric car. Subsidies will be reduced and restricted.

Voters have short memory. What happened in 2020 and 2021 will be ancient history. What will happen in the next two months – the economy, jobs, inflation, gas price – will dominate voters’ mode when they come out to vote on November 8th. So, it’s fair to say it is still too early to predict which state of government would prevail in the next two years.

Financial market is extremely volatile this year. Getting an information edge increases your odds of success. I suggest my readers subscribe to CME market data. Tradingview users already have access to delayed data. A Pro user could upgrade to real-time CME market data for only $4 a month, a huge discount at the time of high inflation.

Happy Trading.

Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
Beyond Technical AnalysisCPIFundamental Analysisinflationmidtermsp500indexTrend AnalysisWTI

Jim W. Huang, CFA
jimwenhuang@gmail.com
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