Democrats took the House of Representatives. Republicans held the Senate. What should investors expect from the US midterm election outcome? In the way of policy, not much. But the new political landscape may be good for markets.
The US midterm election result was in line with preelection polls and isnât likely to change the outlook for the economy. With Congress split between the two major political parties, we think itâs unlikely that major new legislation will find its way to President Donald Trumpâs desk before the 2020 presidential election.
For example, Democratic control of the House effectively dashes any chance of a second round of tax cutsâa scenario that could temper the upside potential for US equities. But with Republicans holding the Senate and the presidency, thereâs little chance that Congress will be able to roll back recent changes and raise tax rates, either.
Democrats may decide to promote infrastructure spending, an initiative that Trump once also cited as a priority, but itâs not clear that Democrats and Trump will be able to work together. Itâs also uncertain there will be bipartisan appetite for another burst of fiscal stimulus so soon after a 2018 tax reform package thatâs estimated to add some $1.5 trillion to the budget deficit by 2027.
The âGridlock Is Goodâ Scenario
But with the US economy doing well, the election results may be the best possible outcomes for financial markets. Historically, gridlock has been good for stocks. Since 1928, the S&P 500 Index has delivered average annual returns in the double digits during years when Democrats and Republicans shared control of Congress.
Markets sent a similar signal after the results rolled in. Global stocks and other risk assets got a boost while US Treasury yields fell modestly, suggesting that traders and investors were happy with a dose of predictability after several years of unexpected election results and developments around the globe.
Within equities, healthcare may benefit from a divided government, which would be unlikely to make major changes to the Affordable Care Act or drug pricing. And static fiscal policy should relieve a source of upward pressure on long-term US Treasury yieldsâbut shouldnât be a major headwind for credit assets.
Fed Expected to Stay On Course
One thing that wonât change with the shifting political winds in Washington is US monetary policy.
The Federal Reserve made it clear before the election that the US economy is strong enough to warrant additional rate hikes well into 2019. We still expect the Fed to deliver another 25-basis-point increase in December and four more hikes next year.
That will present some challenges for asset markets. But continued Fed transparency about its intentions should help to temper overall market turbulence.
Trade Tensions Will Persist
None of this means markets are entering a period of tranquility. The sharp ups and downs weâve seen over the past few months will likely continue in 2019.
One reason: trade tensions are likely to persist. For one thing, the US congressional election result wonât have much effect on Trumpâs trade policies. This is because Congress has over the years delegated much of its trade authority to the executive branch. If the US and China were to reach a deal to end their trade dispute, Congress would be required to vote on it. But in the absence of a formal agreement, trade policy is up to the President.
The trade standoff between the US and China may deepen a Chinese slowdown. And it could be an even bigger threat to growth in countries caught in the middleâthose that depend more heavily on trade than either Washington or Beijing. Whatâs more, tariffs could increase the upward pressure on inflation in 2019.
Stay Active...And Donât Sleep on Volatility
In the US, legislative deadlines loom for decisions on government spending and the debt limit. We expect Congress to meet those deadlines over the next few months and avoid a government shutdown. But market volatility could rise as the deadlines near.
And of course, the political cycle wonât stop spinning. Once the dust from the midterm election settles, attention will turn to the 2020 presidential election. With several sitting Democratic senators likely to throw their hats in the ring, expect more political posturing in Washington. As long as the economy holds up, markets should be able to withstand periodic bouts of turbulence. But politics remain an obvious risk factor.
We still believeâas we did before the electionsâthat market returns are likely to be lower in the years ahead.
Thatâs why we think itâs so important to embrace high-conviction insights and an active approach to portfolio management that incorporates political risk and the potential for policy changes into every investment decision.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
