Investor Takeaways: U.S. Midterm Elections

The Most Likely Outcome

A fundamental characteristic of a competent investor is their ability to assess the impact of world events on financial markets, adjust accordingly and make corresponding gains. The US midterm elections represents a notable shift in party power and thus expected policy implementations. Formerly, the Republican Party held unchallenged control over both the executive and legislative branches of the US government, accompanied by high levels of market growth.

As was predicted by the polls, the Democratic Party has now retaken control of the House of Representatives, whilst the Republican Party strengthened their hold over the Senate, which overall poses a challenge for President Trump’s current agenda.

A Split Congress

Historically, stocks have proven to perform very well under a split congress, given a Republican President. On average the returns on the S&P500 have been upwards of 12% per annum under these conditions. The gridlock caused by a split congress combined with the consumer confidence a Republican president provides, leave little room for dramatic fluctuation, leading to a buoyant market.

Trade with China

Previous instalments have covered the topic of President Trump’s aggressive trade positions, so how are these predictions changed by the midterms?  Investors who have positioned themselves accordingly should expect little changes, as trade relationships are a matter of executive decision, and a Democratic house will have little power to oppose the “trade war”. Expect relationships with China to continue on the current trend.

Fiscal Changes

US and international markets were given a significant boost in the form of GOP tax cuts, to which the Republicans have promised that this is only the first of many. Investors who have positioned themselves accordingly should adjust. It is extremely unlikely that further cuts will be implemented with the US budget now controlled by Democrats. On the other hand, Democrats have promised a reversal of this fiscal policy, specifically a tax increase on upper income households and companies. This however is unlikely to be the case, as their performance in this midterm does not indicate the traction necessary for a Democratic sweep in 2020.

Big Pharma

One particularly industry whose performance is most closely linked with policy is health and pharmaceuticals. Since his campaign, Trump has shied away from pursuing his goal of reduced drug prices through policy intervention. Recent trends in the pharmaceutical would indicate the continuation of current price levels. The S&P 500 health care sector has been a top performer, climbing more than 7% in 2018, and the lack of meaningful regulatory changes are unlikely to derail this trend.

As a side note; Goldman's Government Exposure basket is made up of companies who have over 20% of revenue exposed to changes in governmental policy. Celgene, Regeneron Pharmaceuticals and Amgen are all companies included in this basket. The outcome of this midterm election is expected to favour their performance.

Gains for Defence

One industry that frequently sees bipartisan support is defence. Trump and the GOP have initiated increased military spending and have promised the continuation of such. Democrats, now controlling the house are unlikely to hinder this particular agenda, and have most recently agreed to a defence budget increase for 2019. Defence stocks are likely to receive a significant boost after this election. Already, iShares U.S. Aerospace & Defense ETF is up more than 4% this year, outperforming the S&P500

Overall Takeaways

Markets have already adjusted towards the most likely outcome, therefore few markets will be at significant fluctuation risk. The current conditions and expected gridlock may result in continued, yet more stable and slow growth. As always however, unexpected changes in either policy or governmental conditions could change that, and as a consequence AMSA continues to support a risk minimising portfolio”

Kariem HafezComment