Pennsylvania Election Holds Clues for Stock Market Fortunes

(Bloomberg) -- At first glance, there’s little reason for equity investors to scrutinize Tuesday’s special congressional election in Pennsylvania. To hear it from analysts at RBC Capital Markets, there are reasons they should.

A defeat for President Donald Trump’s Republican party in the district outside of Pittsburgh may weigh on sentiment among conservative voters. They’ve been exceedingly optimistic lately, with a measure of consumer comfort among the group near record highs. For the past 16 months, the indicator has moved with an 89 percent correlation to the stock market, RBC data showed.

If Republicans lose control of either the House or Senate, or even if them seem likely to going into mid-term elections, it could crush optimism among the party’s supporters, according to Lori Calvasina, RBC’s head of equity strategy.

“The relationship between Republican sentiment and the S&P 500 of late tells us this would likely be a problem for stocks,” she wrote in a note to clients Monday.

What’s worse, the bank said, the second year of a presidency has historically ranked last for equity returns in a four-year cycle. The S&P 500 has risen a median 1 percent during mid-terms since 1928, less than a third of the gains seen during the other years. The link is that the party in power often loses seats in Congress, setting the stage for intensifying policy battles.

It’s too early to say whether control of Congress will change hands in November, but available polling in generic races indicates the Republican party will struggle to hold off a potential Democratic surge.

The contest in Pennsylvania pits Republican Rick Saccone against Democrat Conor Lamb in House district Trump carried by almost 20 points in 2016. There’s also a vote in Michigan. The elections follow significant Democratic wins last fall in Virginia, New Jersey and Alabama, and a surge in Democratic turnout earlier this month in a Texas primary.

Investors have taken notice. The impact on the looming fall vote on the stock market has crept up as one of the most frequent questions asked by RBC clients over the past month.

Trump’s move to lower taxes and ease regulations had been embraced by investors until his latest protectionist stance on trade whipped up market volatility. The S&P 500’s total return index rose for 15 straight months from his election through January and then suffered its first 10 percent correction in two years.

Jim Paulsen, chief investment strategist at Leuthold Group, is less worried about politics’ influence on the market. He points to a rebound in sentiment toward government economic policies and suggests a sustained improvement could lead to a virtuous cycle in everything from the economy to the stock market to the incumbent party’s prospects in elections.

Using the University of Michigan’s sentiment survey, he found that the number of people with a favorable opinion of government policies is about to outnumber those with an unfavorable opinion for the first time since 2009. That’s a big turnaround from three years ago, when a net 40 percent showed disapproval.

A lasting rebound to positive readings has occurred twice before, first in the 1980s and then in the 1990s. Coincidence or not, both led to a boom in the economy and the equity market, and more importantly, a second term for the president: Ronald Reagan in 1984 and and Bill Clinton in 1996.

“These days, most are critical of the U.S. government,” Paulsen wrote in a note. “Lately though, many have been feeling better about U.S. government economic policies.”

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