How a Midterm Blue Wave Impacts Markets

Biotech stocks slumped the last time Dems took control of the House in a midterm election

by Rocky White

Published on Nov 6, 2018 at 2:30 PM

Midterm elections are taking place across the U.S. today, as you're likely well aware. Last week, we took a broader look at the impact of these mid-cycle votes on stocks. This week, with expectations calling for the House of Representatives to shift from red to blue, we'll take a look at which sectors won and lost the last time we had a similar changing of the guard in Congress.

ETF Winners & Losers After GOP House Seats Turn Blue

As of this writing, fivethirtyeight.com is projecting a 7 in 8 chance that the Democrats will gain control of the House of Representatives following today's midterm elections. Of course, we all know that polling projections should be taken with a grain of salt following the 2016 presidential election outcome, but it's certainly not unusual for the party in the White House to give up some control in the legislative branch once midterms roll around.

Further, estimates are calling for the Democrats to gain 39 House seats, on average. That would be roughly on par with the outcome of the 2006 midterms, when Republicans lost 30 seats. The table below shows the returns of various sector-based exchange-traded funds (ETFs) after those 2006 midterm elections, sorted by rest-of-year returns.

etf returns after midterm elections 

Housing on Top, Biotech on the Bottom

The iShares Dow Jones U.S. Home Construction ETF (ITB) led the pack after those 2006 midterms, despite an initial dip in the day following the vote. ITB rallied sharply in the week and month after the election, and held onto big gains through year-end. Of course, note the timing; this was prior to the housing bubble's collapse. ITB is down about 26% so far in 2018, but may have just put in a bottom -- the shares hit late-October lows in the $29.50 area, which marked highs in 2015-2016.

itb daily chart 1106

Meanwhile, the SPDR S&P Biotech ETF (XBI) fared the worst after the Democrats took control of the House 12 years ago. The fund was roughly flat the week and month after the election, but eventually slumped to a 9.6% loss through the end of that year. As it stands now, XBI recently broke below support at its year-to-date breakeven level just below $85, and now appears to be fighting resistance at this price point.

xbi one-year daily 1106

Broad Equity ETFs Rallied to End the Year

Finally, from a broad perspective, major market trackers like the SPDR S&P 500 ETF (SPY), SPDR Dow Jones Industrial Average ETF (DIA), and iShares Russell 2000 ETF (IWM) all closed out the remainder of 2006 with solid gains following the midterm elections. SPY was up 1.8% a month after the election, and 2.2% through year-end. The Dow fared similarly well, rising 1% over the next month and gaining 2.4% to close out the year. Meanwhile, the small-cap IWM popped 3.4% in the month after midterms, before paring its gains to wrap up the final innings of 2006 with a 2.4% rise.

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