Mark Lister, 3 November 2022

Financial markets have turned their attention to the US midterm elections, which take place on Tuesday.

Midterms are held near the midpoint of a president's four-year term of office, hence the name. All 435 seats in the House of Representatives are up for grabs, as are about a third of the 100 seats in the Senate.

The sitting president’s party almost always comes off second best in midterm elections, and earlier this year that was the clear trend.

However, after the Supreme Court overturned the constitutional right to an abortion (the Roe v. Wade decision from 1973) in June, Joe Biden's Democrats experienced a strong boost in the polls.

Things have swung back toward the Republicans more recently, so we're in for an interesting race in many parts of the country.

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There are so many topical issues for voters to focus on, including widespread concern about the rising cost of living, the war in Ukraine, and the strong stance taken by the US around the independence of Taiwan.

Midterm elections usually have a turnout of around 40 per cent, well below the 60 per cent we often see in presidential elections. Maybe that long list of worries is why interest seems a lot higher this time around.

It wouldn't be America if there weren't a couple of pseudo-celebrities looking to transition into politics.

Former NFL player Herschel Walker is running in Georgia, while Mehmet Oz (from daytime talk show "The Dr Oz Show") is a genuine chance in the Pennsylvania Senate race.

At present, the Democrats have control of both the House of Representatives and the Senate, albeit with a very slim margin in the latter.

The Republicans are expected to take control of the House, although the Senate race looks tighter. With President Biden - a Democrat - in the White House, the US is headed for a divided government.

Ironically, that mightn’t be all bad for Biden in the short-term, as this situation can sometimes lower the expectations on an incumbent president.

Looking ahead to the 2024 presidential election, however, it might not be quite so helpful.

Midterms are generally considered an unofficial referendum on the first two years of a presidential term, and Biden's approval ratings haven’t been great over the past 12 months.

A weak showing from the Democrats might add to those challenges, encouraging his rivals and intensifying the calls for Biden to step aside in 2024.

For investors, midterm elections have traditionally been a positive catalyst for the US sharemarket.

With the sitting President’s party usually losing ground in the midterms, this often leads to gridlock in Washington.

Historically, that’s tended to be a market friendly outcome. It limits the ability of politicians to make significant changes, forces compromise, and means businesses can operate without fear of major policy shifts.

Since 1950, there have been 18 midterm elections. In the 12 months following each of these, US shares have been higher in every case, with an average of 15.1 per cent for the S&P 500.

That’s well ahead of the average gain in all 12-month periods since 1950 of 9.3 per cent.

Despite that impressive track record, a strong run is far from guaranteed. The economic backdrop has been very different on each of those previous occasions, and that’s especially true today.

However, financial markets like to know where they stand, which could be why they often strengthen following political events like this.

This year’s midterms will be fascinating for a range of reasons, and they just might help markets find a bit of stability too.