- Stocks usually rally after midterm elections as political gridlock is often the result, preventing big policy swings that scare investors.
- But a rally after this midterm cycle is unlikely as the Fed's aggressive rate hikes have raised the odds of a recession, BlackRock said.
A stock market rally after next month's midterm elections is unlikely, as the Fed's continued rate hikes will weigh on investors and raise the risk of recession, BlackRock warned in a note on Monday.
Stocks usually gain after midterm elections as political gridlock is often that result, preventing big policy swings that scare investors. But that's not the case this year, BlackRock analysts said.
"We don't see that past playbook working this time due to the recession we expect from the Fed ratcheting up rates," analysts said. "We see a bigger problem for stocks than any potential positives from the midterm election outcome: a looming recession."
Those recession risks, along with the resulting damage to earnings, haven't been fully priced into the stock market, BlackRock added.
And any fiscal stimulus that's meant to blunt the impact of a slowing economy would threaten to stoke inflation and bring volatility to markets, according to the report. That could recreate the chaos seen in the UK, when the plan for unfunded tax cuts roiled debt markets and forced the Bank of England into emergency intervention.
Meanwhile, the Fed eventually will ease up on its rate hikes, but it will be too late to save the economy, BlackRock predicted. Rate-sensitive areas of the economy are already showing signs of damage, it said, pointing to skyrocketing mortgage rates and the falling number of new housing projects.
"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 of this outweighs any expected boost for stocks after the midterms, in our view," analysts said.
BlackRock echoed alarms from other experts about stocks. Earlier this month, JPMorgan CEO Jamie Dimon predicted a recession to hit the US economy in six to nine months, causing stocks to lose an "easy 20%", and "Dr. Doom" economist Nouriel Roubini warned there could be an even steeper plunge of 40%.
Economists say that's largely because the Fed had a delayed response to rising inflation, meaning the central bank could be hiking rates too aggressively and risks tipping the economy into a downturn.
And while Fed officials have hinted at pausing rate hikes, the central bank is still likely to remain focused on restoring their credibility in the inflation fight – which is crucial to not letting high inflation expectations get entrenched in the economy.
Ned Davis Research warned that any gains in the market would be fleeting until the Fed signals a true policy pivot, which would only happen if there's softer labor market or inflation data, or if "something breaks in the financial system."