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ETF Strategies for the Midterm Elections

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Heading into the mid-term election, which is now just two weeks away, political gridlock in Washington persists. This is especially true as chances of an outcome consisting of a Democratic-controlled House and Republican-majority Senate seems likely.

Per a Washington Post/Schar School poll, 50% of voters support Democratic candidates and 47% support Republicans. An NBC News/Wall Street Journal poll showed that 50% of likely voters want Democrats to control Congress compared with 41%, who want Republicans to maintain control. A RealClearPolitics average of polls gives Democrats a 7.7% generic ballot edge while FiveThirtyEight gives Democrats a six in seven chance of winning the House. CNN's Harry Enten predicts in The Forecast that Democrats will win a 17-seat majority in the House but Republicans will maintain their slight edge in the Senate.

A number of analysts believe that the divided government or a Democrat win of the House would lead to a government gridlock and prevent the government from enacting new policies, keeping the status quo. A divided policy would probably keep America's fiscal, trade and regulatory policies on the same trajectory (read: Trump's Approval Rises Before Midterms: ETFs to Lose/Gain).

The divided government many not actually derail the nine-and-a-half year bull market but might reshuffle the sector winners and losers.

If we go by history, there has been an apparent difference in the performance of the stock market in the fourth quarter since 1982 — between the period before the election and after the election. Stocks have performed markedly better in the period from the start of Q4 to the day prior to the U.S. midterm elections, with the S&P 500 gaining an average of 5.7%, trading positively 100% of the time. On the other hand, the period following the elections doesn't tend to perform that well as the S&P 500 gained an average of just 2.7% with a positive trade of just 66% of the time.

Given this, investors should focus on some strategies as to which sector should they take positions or which should be avoided if bipartisan government forms. We have highlighted them in detail below:
Focus on Pharma

The split government will benefit the pharma sector most as it would reduce the likelihood of the major regulatory changes regarding drug pricing. As such, pharma ETFs like iShares U.S. Pharmaceuticals ETF IHE, SPDR S&P Pharmaceuticals ETF XPH, VanEck Vectors Pharmaceutical ETF PPH, Invesco Dynamic Pharmaceuticals ETF PJP and First Trust tNasdaq Pharmaceuticals ETF FTXH are exciting bets. All these funds currently have a Zacks ETF Rank #2 (Buy).

Cautious on Defense

Defense sector has been the major beneficiary of Trump administration thanks to an increase in military spending. However, the gains might erode quickly if Democrats win the House as defense spending is less of a priority for them. Given this, investors should trade cautiously in three defense ETFs — iShares U.S. Aerospace & Defense ETF ITA, SPDR S&P Aerospace & Defense ETF XAR and Invesco Aerospace & Defense ETF PPA. These funds currently have a Zacks ETF Rank #2 (read: Top Performing ETFs of the Third Quarter).

Buy Alternative Energy

Trump has kept the alternative energy space under pressure giving the downtrodden coal a major boost. The trend will likely reverse as Democrats support renewable energy and climate change. Thus, Invesco Solar ETF TAN and iShares Global Clean Energy ETF ICLN could be a worth looking. Both products are down 26.7% and 10.7%, respectively, so far this year. TAN has a Zacks ETF Rank #4 (Sell).

Avoid Banks

On May 22, the Congress approved a plan to dismantle the Dodd-Frank Act, which was enacted in the aftermath of the financial crisis and crimped some of the business lines of the banks. The Democrats controlling the House would strengthen the regulation of the financial sector with more investigation and hearings of big banks and Wall Street firms. With this, bank ETFs like SPDR S&P Regional Banking ETF KRE and SPDR S&P Bank ETF KBE could be negatively impacted. Both funds have a Zacks ETF Rank #3 (Hold) (read: Regional Bank ETFs & Stocks to Party on Dodd-Frank Easing).

Trump seeks to deregulate the industry and dismantle the Dodd-Frank Act, which was enacted in the aftermath of the financial crisis and crimped some of the business lines of the banks.

Bet Big on Infrastructure

The infrastructure sector is expected to get a boost as democrats will also likely to go ahead with the Republican plan. Trump has promised to spend trillion dollars on infrastructure by rebuilding highways, bridges, hospitals and other infrastructure projects over 10 years. The approval is expected to come after the mid-term election. As such,iShares Global Infrastructure ETF (IGF - Free Report) and SPDR S&P Global Infrastructure ETF GII seem lucrative picks. Both ETFs are down 7.7% each.

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