In the U.S. midterm elections, the Republicans have expanded their majority in the Senate while the Democrats, as the polls predicted, are on track to take control of the House of Representatives. Despite this victory, the outcome falls rather short of some Democrats’ hopes, and the Republicans will see it as a positive outcome for President Trump, who has clearly managed to recharge his base.
Immediate market reaction has been limited. At the time of writing, U.S. stock futures have managed a slight gain and the 10-year Treasury yield has gone below 3.2%. Asian stocks have fallen slightly.
From an investor’s perspective, what is important is how the election outcome will shape policy actions which could, in turn, alter our fundamental view on various asset classes. The policies in question range from local issues like immigration and health care to global topics such as trade and tariffs. The "divided Congress" outcome (which seems very likely), is not necessarily a bad outcome when looked at from the prism of historical stock market returns. In previous U.S. Administrations where the President was Republican and the Congress was split (Republicans with a Senate majority and Democrats in control of the House of Representatives), the S&P 500 historically has generated a total return of around 10.8% (going back to 1933).
Encouragingly, the S&P 500 has also not declined in the 12 months after a midterm election going back to 1946. This usually happens because the incumbent President is looking for his re-election and hence is more likely to cut a deal on fiscal spending or other aspects of the budget so as to spur economic growth. In case of President Trump, the more likely scenario will be progress with the Chinese on trade or the striking a deal on infrastructure spending (something the Democrats are open to discuss). However, the historical precedents did not feature trade conflicts, so the next 12 months might be different.
Better outcomes for the Republicans usually translate to positive price movements in the following industries –defenceand aerospace (as the defencebudget goes up), fossil-fuel based energy companies and financials (on hopes of deregulation). On the other side of the coin, better outcome for the Democrats have been seen as positive for healthcare and alternative or clean energy and these could be potential relative underperformers.
In the current gridlock scenario there is a high likelihood that there will be cooperation between the Democrats and President Trump to implement new fiscal policy in the form of increased infrastructure spending, which is something both the sides agree on. Exactly how the government will fund these projects will need to be addressed. With the recent tax cuts, the U.S. long term budget outlook looks increasingly bleak. The Trump administration may encourage public-private partnerships as a possible solution, opening the door for new investments. Additionally, increased Democratic seats in the House of Representatives could create a check on President’s trade war.
While these are some of the positive policy implications, there are possible negative ones. Next year Congress need to approve the revised NAFTA agreement and raise the debt ceiling, and a Democrat-controlled House may make it more difficult to reach a consensus. Other aspects of the President’s legislative agenda could also be blocked and delayed. But, overall, this is probably not a market-unfriendly outcome, although we will continue to monitor and communicate on its likely implications.
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