Goldman Warns Midterm Elections Raise Risk Around Fiscal Deadlines

The US midterm elections taking place on November 4 may very well lead to a shift in Senate control to Republicans from Democrats, according to Goldman Sachs. They argue that a Republican-controlled Congress could renew legislative activity – at least on small issues – but also increase (unwanted) uncertainty on some larger ones creating risk around fiscal deadlines.



Goldman notes,

The US midterm elections taking place on November 4 may very well lead to a shift in Senate control to Republicans from Democrats. We ask four experts, one question each about the largest potential impacts of the election and of the possible Senate turnover in particular. They argue that a Republican-controlled Congress could renew legislative activity – at least on small issues – but also increase (unwanted) uncertainty on some larger ones. And they conclude that a shift to a Republican-controlled Senate would – intuitively – affect the healthcare sector, but – not-so-intuitively – may not directly impact defense. But with Democrats well positioned for material gains in 2016, Larry Sabato, a political expert at the University of Virginia, cautions that Republicans would need to use any newfound power wisely.


Q. Would a Republican takeover of the Senate in 2014 benefit Republicans in 2016?

A. Larry Sabato, Professor and Director of the Center for Politics, University of Virginia: Two years is four eternities in politics. After the GOP sweep in 2010, the Republican mantra was, “Even my dog could beat President Obama in 2012.” For every action, there can be an equal or opposite reaction in politics as well as physics. The same thing could happen this time if the Republicans do not use their newfound total control of Congress (assuming that happens) judiciously and strategically.

Q. What are the biggest potential policy implications of a possible Republican takeover of the Senate?

A. Alec Phillips: A Republican Senate majority would likely lead to an incremental uptick in legislative activity – potentially even on a couple of big issues, including tax reform – and increased risk around fiscal deadlines.

On some smaller issues, congressional Republicans would be more likely to advance legislation to the President that congressional Democrats have previously managed to hold back. This might include “fast track” authority to negotiate trade agreements, energy-related issues such as the Keystone pipeline or LNG export approvals, and incremental changes to the Affordable Care Act (ACA).


We would expect less movement on bigger structural reforms where bipartisan agreement would still be necessary, like entitlement reform or immigration reform. However, we do see some possibility of bipartisan cooperation on corporate tax reform and infrastructure funding, which both parties have identified as priorities for the coming year and where partisan differences have tended to be less acute than in some other areas.


Although Republican leaders would want to demonstrate an ability to govern, the most disruptive debates typically occur in non-election years, when the electoral consequences are theoretically lower. Moreover, if Republicans gain majorities in both chambers, the well-worn routine that markets have become accustomed to – the House passes a debt limit increase or spending package coupled with controversial policy changes, the Senate strips out those changes, which the House passes just before the deadline often with significant Republican opposition – will change. While we have little doubt that the debt limit would ultimately be raised and that spending authority would eventually be extended, we would expect a change in control to increase political uncertainty, at least until markets become accustomed to the new routine.


The margin of victory (should the Republicans win the Senate) bears watching. Most observers expect the election to result in 49 to 54 Republican Senate seats. Intraparty disagreements in both parties could make legislating with a narrow majority difficult. A narrow Republican majority might also tempt Democrats to “run down the clock” in anticipation of winning back the majority soon, as the electoral math in 2016 favors Senate Democrats nearly as much as it favors Republicans this year. If Republicans manage to win 53 or 54 seats, they could have a working majority on many issues – this is particularly important in the budget process, where only a simple majority is usually required – and a majority of that size would keep open the possibility of a Republican-controlled Senate post-2016.

Q. Would a Republican-majority Senate lead to a meaningful shift in healthcare policy?


A. Matthew Borsch: Potentially. There are two possible scenarios for healthcare policy should Republicans win the Senate with different stock implications: (1) continued gridlock, which might benefit hospitals and other provider companies doing well under the status quo, and (2) compromise, which would likely be supportive of medical devices and managed care.

Continued gridlock: no compromise on health policy and no major healthcare legislation would be enacted. Republicans might attempt to pass legislation to repeal (and in some fashion “replace”) the ACA but would likely be blocked by the President’s veto. Meanwhile, the ACA implementation would continue with increasing enrollment in the ACA public exchanges and under expanded Medicaid. At the state level, some (but not all) of the states that have opted out of the ACA Medicaid expansion may decide instead to participate (particularly given the likelihood of continued lobbying pressure from various healthcare stakeholders). Under this scenario, stock implications would be positive for hospitals and other provider companies that benefit under the status quo (i.e., no changes to the ACA).


Compromise: a deal between Democrats and Republicans would be made such that “bipartisan support” for the ACA is achieved in return for some changes to the law. The logic for Republicans to reach this outcome would be: (1) outright repeal of the ACA won’t be possible while President Obama remains in office, and (2) Republicans may face a “use it or lose it” with their leverage since electoral math suggests Democrats could regain a majority of Senate seats in Nov. 2016. If a compromise were reached, possible changes to the ACA might include: (1) repeal of some of the ACA “industry fees” (the medical device revenue tax appears to top the list), (2) block grants to states for Medicaid expansion, and (3) greater flexibility for product offerings under the ACA exchanges. Under this scenario, stock implications would be positive for medical devices and managed care but potentially negative for hospitals and other provider companies (e.g., labs, emergency care providers).


The US Supreme Court (SCOTUS) decision on the use of subsidies on federally-run ACA exchanges could add complexity to either of the above scenarios. In the event that SCOTUS rules against the use of subsidies, the Obama administration would likely make changes to exchange administration to meet a legal definition of ACA exchanges that are “established by the states.” However, doing this may provide an opportunity for some Republican-led states to “opt out” of the exchange subsidies (i.e., similar to the Medicaid expansion “opt out”).

Q. Would a Republican-majority Senate be positive for defense spending and, ultimately, defense stocks?

A. Noah Poponak: Not necessarily, as neither outcome makes a particular defense spending trajectory more likely. Still, even if investors expect sequestration to remain in force, they can feel confident in a near-term floor for defense spending.

Despite what some would expect, an analysis of the direction of defense spending and the performance of defense stocks around past midterm elections – for periods in which majority control of Congress shifted between Republicans and Democrats (or didn’t) – suggests that there is no discernible trend in spending or defense stock performance.


The political landscape for defense is currently mixed across parties. In the upcoming elections, there are Republicans in favor of increased defense spending, but there are also Republicans pushing for lower government spending overall. There are Democrats that want to see less defense spending, but there are also Democrats who support less focus on spending cuts.


For the time being, we are basing our defense spending views on the math of sequestration (the automatic annual cut in spending each year for ten years that came into effect in 2013), the Pentagon’s priorities and plans, the geopolitical landscape, and the overall US budget strategy more so than the outcome of the midterm elections. We like the current risk/reward for Defense because we think investors can own Defense stocks even assuming that sequestration sticks, since it is well understood and creates a near-term bottom in Defense spending. And upside revisions to defense spending relative to this baseline are much more likely than downside revisions.

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