Equities usually do well after U.S. Midterms but the same cannot be expected this time due to the recession. BlackRock’s weekly commentary says that they are staying underweight developed market (DM) stocks. BlackRock is also underweight U.S. Equities as the Fed intends to raise rates into restrictive territory. The year-to-date selloff partly reflects this and yet valuations have not come down enough to reflect weaker earnings prospects.
The recession BlackRock sees from Federal Reserve rate hikes eclipses any impact from U.S. midterm elections. The commentary goes on to suggest:
We see a bigger problem for stocks than any potential positives from the midterm election outcome: a looming recession. We have argued how central banks rushing to hike policy rates to get inflation back to target would need to crush interest rate-sensitive parts of the economy first.
Recession will pressure other sectors in time, but we’re already seeing damage in important rate-sensitive sectors like housing. As mortgage rates soar along with the Fed’s aggressive rate hikes, the number of new housing starts is falling quickly. Rising input costs also pose a risk to elevated corporate profit margins. Central banks appear set on reining in inflation by crushing growth – increasing the risk of the post-Covid restart being derailed.
A higher risk premium and worsening macro backdrop lower our expected equity returns. But we expect central banks to ultimately live with some inflation and look through the near-term risks.
We see political focus increasingly shifting to the economy. We expect inflation to come down, but stay above target – and recession will still hit. We then think the politics of inflation could switch to the politics of higher interest rates. We see the politics of rates creeping into the politicization of everything with more voices beginning to decry the aggressive rise in interest rates that is causing a recession.
We see the Fed stopping its hikes amid the economic damage and pressure to ease up on tightening, but price pressures will persist. That’s why we think it will eventually have to live with some inflation.
We see rising rates causing recession as inflation persists. The Fed is responding to the politics of inflation, or the pressure to tame it, we think. We see the Fed pausing but only after the economic damage of rate rises is clear. All this outweighs any expected boost for stocks after the midterms, in our view. We eventually see the politics of rates overtaking the politics of inflation as political focus sharpens on the economy into the 2024 elections.