Divided government could stabilize yields and boost stocks, analysis suggests

A divided government scenario where the Democratic Party of Korea controls the House could stabilize Treasury yields by checking fiscal spending. While the S&P 500 has historically risen by an average of 16.6% in the year following midterm elections, potential government shutdowns remain a source of short-term volatility.

As the United States midterm elections approach, attention is turning to the economic scenarios and stock market movements that may emerge as market uncertainty is resolved. According to an analysis by economics professor Kim Kwang-seok, the resulting political landscape will likely have a decisive impact on future Treasury yields and the rotation of leading stocks.

Positive Market Scenario from Political Deadlock

The market is currently moving under the assumption that the Democratic Party of Korea will control both the Senate and the House. This outlook is supported by various institutional forecasts and polling results from organizations such as Polymarket and JPMorgan. Professor Kim analyzed that the stock market is currently reflecting these expectations in its entirety; for example, AI semiconductor stock prices have shown a downward trend as if reflecting the Democratic Party of Korea's position, while the bio sector has shown strength.

In particular, a deadlock in the form of a "Divided Government," where the Republican Party retains the Senate and the Democratic Party of Korea takes the House, could represent the most positive scenario for the stock market. This is because a House controlled by the Democratic Party of Korea could exercise its budget veto power to check the massive fiscal spending of the Trump administration. Such checks and balances could serve as a basis for stabilizing Treasury yields by suppressing increases to the debt ceiling.

Tariff Wars via Executive Orders and Shutdown Variables

If legislative power in Congress is limited, a powerful tool available to President Trump is the executive order. This is because trade tariff measures can be implemented through presidential orders without passing through Congress. Consequently, there is a possibility that tariff wars over major items such as automobiles, steel, and semiconductors could intensify. However, some observations suggest that as President Trump enters a lame-duck period in the latter half of his term, the impact of tariffs during negotiations with foreign governments may not be as strong as in the past.

A potential government shutdown is cited as a short-term uncertainty factor. If the House is uncooperative regarding debt ceiling increases or budget processing, a situation where government functions are temporarily suspended could recur, as seen in past cases. This is a factor of temporary volatility that could emerge immediately following the election results.

Market Trends Following Midterm Elections Based on Historical Statistics

Looking at historical data, market trends around midterm elections show a consistent pattern. Just before an election, the stock market may contract or funds may flow into Treasuries due to uncertainty, but once the election concludes and uncertainty is removed, the market has tended to show strong rallies. In fact, the S&P 500 index has risen by an average of 16.6% during the one year following midterm elections.

Based on the four-year cycle of an administration, the periods before and after elections show strength, the second year shows relative weakness, and the fourth year shows a trend of entering a lame-duck period. Professor Kim explained that while these historical trends should be referenced, investment funds will move according to the political tone determined by the election results, leading to the formation of new leading stocks.

Source: original video (YouTube)