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Wall Street's investment banks are advising clients on what to expect from the 2018 midterm elections and how to invest around those outcomes.
While most of the banks still expect the Democrats to take back the House of Representatives and split Congress, some analysts suggest chances are increasing for a Republican or Democratic sweep.
Bank of America Merrill Lynch, for example, told clients "we still think a split Congress is the most likely outcome but the probability of a 'blue wave' election in the House appears to have diminished."
Goldman Sachs suggested investors keep an eye on pharmaceutical stocks, which could rally if Congress ends up divided, the bank speculates. The firm's strategist contends a split Congress reduces the likelihood of an agreement to reduce drug prices.
Others highlighted the importance of trade policy and implications for U.S.-Chinese relations.
Here's what Wall Street is telling clients going into the 2018 midterm elections:
"Markets generally do well under gridlock. A modest infrastructure bill might see bipartisan support, which could lift Industrials and Materials. A Republican sweep could be equally positive for the overall market as gridlock, as a coordinated Congress could move to enact pro-growth measures. These could include another round of individual tax cuts, or making select tax cuts permanent. ... Meanwhile, a Democratic sweep could increase the risk of congressional investigations. And while this scenario is currently not on the table, in the event of impeachment proceedings, it could be classified as an exogenous macro 'shock.'"
"Our base case implies slightly weaker fiscal stimulus and growth, as well as little reason to expect friendlier trade policy, which translates, in our view, to downside risk to Treasury yields. That said, there has been a lot of focus on how many seats the Democrats can maintain in the Senate, so if Republicans gain more than a slim majority, we could see higher yields even under a divided Congress. Implications for the Dollar appear more ambiguous...
The reaction this year may be different than in the past, particularly given the lower sensitivity of markets to elevated political uncertainty in recent years (based on historically low volatility) and the current fiscal boost likely to fade over the coming years, both of which are unusual around midterm elections. Our equity strategists have also noted that relevant sectors and baskets appear to be pricing few changes to the direction of policy, in line with our expectations. " — Karen Reichgott
"Our suspicion is that there will be limited bipartisanship that will extend only to things like the debt ceiling, sequester relief, and other 'must pass' bills. The Venn Diagram of potential areas of compromise includes everything from infrastructure and drug pricing, to a federal minimum wage hike and student debt relief. Keep in mind that many Democrats are in a similar policy place as Trump on trade. Under almost any election scenario, the prospects of another patch in the Budget Control Act (sequester) that will see a modest increase in defense spending seems likely." — Chris Krueger
"Our equity strategists believe that the environment is ripe for an equity rally into year end. Markets have historically rallied around midterm elections, though this is equally due to historic coincidence (growth has tended to be strong around elections) as the actual elections. Still, we expect this scenario to repeat, as growth looks strong, positioning is light, and Democratic gains could act as a check on the president's trade war policies. On the other hand, some Democratic politicians have expressed support for President Trump's trade war, so they may actually support an escalation against China." — Quinn Brody
"We see few sustained market implications if the midterms result in a divided Congress. Our base case sees strong U.S. growth underpinning the global expansion, yet the range of possible economic outcomes is widening with a skew to the downside. We remain pro-risk, but advocate building greater resilience into portfolios. We favor quality companies, especially those with strong balance sheets, and find those predominantly in the U.S." — Richard Turnill
"We don't believe in the view that divided government leads to status quo events. Midterm elections are inflection points for stocks. ... A China trade deal and indexing capital gains to inflation could be done without an act of Congress. De-regulation, which is helping productivity, will continue. Our concern is that there will be a debt ceiling fight in mid-2019 with House Democrats pushing for an increase in corporate tax rates as a condition of a debt ceiling increase. It is likely Trump will try to cut a deal with Democrats on infrastructure, drug pricing, and/or the minimum wage to avoid a major debt ceiling fight and to avoid tax increases." - Dan Clifton
"While parsing out the likely election outcomes and looking back for historical precedents does not lead to particularly clear conclusions (in part because of small sample sizes), the most robust result we have found is that economic, fundamental and market outcomes tend to improve in the two years following a mid-term election, without regard to President or party."
"As a relative outperformer, the market hasn't onboarded many of the nonpolicy concerns that have been key to this year's 'rolling bear market' across asset classes. Hence, even if election night drives a constructive near-term narrative for credit, perhaps on tax policy, we would use any rally to continue moving up in quality." — Michael Zezas
"While a House majority switch suggests markets returns could disappoint in 2019, we do not see this as pointing to a more protracted economic or equity market downturn. In fact, these midterms switches have not preceded major turning points for markets ever. We still look for a rally into year-end, driven by strong seasonals and midterm seasonals as well as performance chasing." — Tom Lee
WATCH: How the midterms will affect Trump's economy