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Market Extra: The worst outcome for U.S. stocks would be a Democratic sweep of the midterms, Wall Street strategists say

The worst-case scenario for U.S. stocks from Tuesday’s midterm elections would be a sweeping Democratic victory, according to market strategists from Rabobank and Bank of America.

Although Wall Street analysts generally assign slim odds that the Democrats will strengthen their grip on both chambers of Congress after Tuesday’s vote, at least two investment banks told clients that a Democratic sweep would be the worst outcome for U.S. stocks.

See: What midterm election results mean for the stock-market bounce, according to Morgan Stanley’s Wilson

A team of Rabobank analysts led by Senior U.S. Strategist Philip Marey said in a recent note that polls suggest odds of a Democratic sweep are just 15%. Should this outcome materialize, stocks would likely suffer as a federal government dominated by Democrats increases spending, raises taxes and tightens regulation on a wide swath of industries.

While worsening inflation would likely push up Treasury yields and hurt U.S. stocks, there’s also a chance that higher taxes could help to pressure Treasury yields over the long term. Since the start of the year, higher Treasury yields have tended to hurt stocks, and vice versa.

“As far as Democratic control of both chambers of Congress brings more government spending, it could add to inflationary pressures which should push up US treasury yields,” Marey said.

A team of strategists at Bank of America was even more overt, saying that a Democratic sweep would likely result in a “knee-jerk sell-off” for stocks.

Poll suggest that the most likely outcome on Tuesday is a split Congress, with Republicans retaking control of the House, while Democrats are expected to retain their tenuous grip on power in the Senate, according to a team of analysts at Goldman Sachs Group.

An aggregation of polling data courtesy of FiveThirtyEight cited by the Goldman team showed Republicans are expected to control 230 House seats after Tuesday’s vote. Odds of them retaking the lower chamber are roughly 84%, the team said.

However, an analysis of the five most closely contested Senate races suggests a much tighter race, with the odds slightly favoring Democrats.

According to a Goldman analysis of the five most closely contested races, Republican candidates Herschel Walker, in Georgia, and Adam Laxalt, in Nevada, have the best odds of defeating their Democratic opponents.

Assuming Democratic candidates prevail in the three other races, both Walker and Laxalt would need to win for Republicans to retake the majority in the Senate.

To be sure, it’s possible that investors won’t know which party prevails until later in the week, according to a Tuesday report in the New York Times.

For now, investors appear to be shrugging off this uncertainty: the S&P 500
Dow Jones Industrial Average

and Nasdaq Composite

are all hanging on to solid gains for the session.

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