Mid-term elections may be a non-event for many Americans, but this year’s could be a major market-mover. All 435 seats in the House of Representatives are up for election and 33 of the 100 Senate seats will be in play. 

As politics have become more partisan, it seems the effect of legislative control has increased on specific sectors and industries.

As party policies and agenda have aligned with particular industries, companies in those industries benefit from improvement in investor sentiment when the current of control changes in Washington.

And if history is any guide, the change in Washington may not be a change in the current but a massive tidal wave.

#-ad_banner-#​History Has Not Been Kind To The Controlling Party
Mid-term elections almost always go badly for the party that holds White House, especially when it controls Congress as well. 

In the last 18 midterm elections since World War II, the party that held the White House lost an average of 25 House seats and 4 Senate seats. Losses tend to increase when the same party controls Congress and the Presidency, with an average loss of 33 House seats and 5 Senate seats.

Public mistrust of the government could amplify that trend this year.

A CNN survey released late December showed Democrats ahead with a 56% to 38% lead over Republicans in a generic congressional ballot. That’s the largest lead in a December poll going back to 1938, as far back as data is available.

It’s larger than the pre-election lead in 2006 when the Democrats retook congressional control with a gain of 37 seats and larger even than the 2010 lead when the Republicans swept Congress with a gain of 97 seats.

Republican control of Congress and the White House has allowed the party to push through tax cuts and other policy changes, but that might not last long. Democrats need a win of just 24 seats to take control of the House. The surprise election of Democrat Doug Jones to the Alabama seat means Democrats need just two more seats for control in the Senate.

Special elections last year to fill administration vacancies seem to confirm the wave for Democrats. The party pulled off a surprise victory in the Virginia governor’s race along with wins in traditionally red-states like Oklahoma, Louisiana, and Iowa.

Most polls favor the Democrats to take control of the House, though the party might not take the Senate due to a tough electoral map for seats. 26 of the 33 Senate seats up for reelection are held by Democrats, meaning they may have a tough time protecting all those seats while gaining ground on the seven republican-controlled seats. 

A win in the House would still fracture congressional control and would almost certainly affect the legislative agenda.

Who Wins And Who Loses If Democrats Win
Politics aside, the change in legislative agenda could benefit industries traditionally favored by Democrat spending while weighing on those favored under Republican-control. While neither party completely favors nor neglects particular industries, policies have aligned with specific sectors over the last decade.

Investor sentiment could start to swing towards the Democrat-favored industries and away from those favored by the Republicans even before the midterms as more polls are released, meaning investors may want to take a position at least several months ahead of the elections.

Winners
Healthcare, especially hospital networks, could do well as Democrats use their new bargaining power to save the Affordable Care Act. The Healthcare Select Sector ETF (NYSE: XLV) has underperformed the broader S&P 500 by nearly 5% over the last three months as a repeal of the individual mandate became more likely in the tax package. 

With most of their business with the United States, healthcare companies should also benefit from a change in the tax rates. Data from the Stern School at NYU estimates an average effective tax rate of 31% for hospitals and healthcare facilities before the reform, well above the average rate of 25% across all industries. 

Alternative energy companies could also do well if the Democrats use their new position to balance the President’s moves in the energy space. The Guggenheim Solar ETF (NYSE: TAN) surged 50% in the six months around the 2006 mid-term elections when the Democrats picked up 37 seats to take congressional control.  Alternative energy companies will also benefit from the immediate tax deduction for capital spending under the tax reform.

One To Avoid
Defense spending could take a hit as Democrats bargain for balanced spending in other programs. The President outlined his 10-year budget proposal last May, calling for a cut of $1.4 trillion in non-defense discretionary spending while increasing defense spending by $469 billion over the decade. The iShares US Aerospace & Defense ETF (NYSE: ITA) jumped 27% in the six months around the 2010 Republican wave when the party picked up 97 seats to sweep Congress.

Risks To Consider: If recent elections have taught us anything, it’s that polls can be wrong and the most likely outcome can shift quickly over the next ten months.

Action To Take: Rebalance into industries that will likely do well as the market prices in the outcomes of mid-term elections with long positions in hospital networks and alternative energy stocks while avoiding industries like defense that could take a hit on a change of control.

Editor’s Note: Introducing our top 10 stocks for 2018. Stock #2: lets you own a stake in every Hollywood movie and yields 12.6%. Stock #3: has higher profit margins than 98% of all companies on the S&P 500. Click here to get their names and ticker symbols.