Just ending the uncertainty around the midterm elections is likely to spark a relief rally, and strategists say it could be the start of a very good time for stocks, especially if Republicans hold onto both houses of Congress on Nov. 6.
For weeks, the market has been pricing in a scenario where Republicans keep a lead in the Senate, possibly adding a few seats, but lose control of the House of Representatives to Democrats. That is the scenario that would be most neutral for stocks, according to strategists.
Polls had shown Democrats gaining some traction several weeks ago in Senate races, but those gains have faded away and the Republican Senate lead looks more secure. According to FiveThirtyEight, there are 80 percent odds the GOP holds the Senate, up from 68 percent chance late last month, but there's an 84.5 percent chance that Democrats take the House.
Morgan Stanley policy strategist Micahel Zezas said the case for divided government has become more likely, as Democrats slip in the polls. A split Congress would be mildly bullish for Treasurys, with less of a chance that more tax cuts get passed, and bearish for the dollar. For stocks, it would be neutral
"Democrats standing in the polls have decreased in a few key traditionally red states: Indiana, Missouri, Tennessee and North Dakota, but have improved in purple/blue states: Ohio, Florida, Arizona and New Jersey. On the whole, this means that Democrats can no longer win all of the toss up races to win the majority," Zezas wrote. He said what is not clear is whether the fight over Supreme Court Justice Brett Kavanaugh would affect Senate races and House races differently.
The latest CNBC All-America Survey shows it's unlikely there will be a big blue, or Democratic wave, and recent polling has shown Republicans closing the gap in some key senate races.
"Last month, the Republicans had a 75 percent probability of winning the Senate, but the polls showed a 50-50 Senate. Most notably, open Republican-held seats in [Arizona] and [Tennessee] were not trending in the Republicans' favor and undecided voters usually break against the President's party in midterm elections," wrote Daniel Clifton, head of policy research at Strategas. "The probability of a GOP Senate seemed too high to us. But the recent bounce in enthusiasm for Republicans is now being confirmed in [North Dakota, Tennessee, Arizona Nevada] and [Indiana] polls. We caution there are still six races in the margin of error and how the undecided voters break will be key. They usually move in unison."
Clifton said stocks are not pricing in the surge in betting odds for a Republican sweep. In early October, betting on Predict.it showed a divergence in expectations, with odds for a split congress and a full Democratic sweep falling while the odds of a Republican sweep rose. The odds of s split Congress are still 58 percent, and for a Republican sweep, 36 percent.