In a refreshing change from recent election history, forecasts for the latest US mid-terms proved to be surprisingly accurate.
As the House of Representatives turned blue and fell into the hands of the Democrats, Republicans tightened their grip on the Senate.
While this lack of surprise meant markets remained largely unmoved, investors’ focus has now shifted to what this means for the next two years, particularly with regard to the effect of a divided Congress on President Donald Trump’s decision-making ability moving forward.
Certain points of contention between President Trump and the Democrats may cause some initial stock volatility as debates over lowering drug prices and infrastructure spending take effect, but gridlock still seems the most likely outcome from both sides.
Having said this, US equity markets have appeared quite content with political gridlock in the past given it has led to checks and balances on spending and often resulted in reduced legislation and less red tape for businesses.
The simple fact that this specific point of political uncertainty is now out of the way is a positive development, with the seasonal element going into year-end also likely to put an upwards spin on markets, particularly with the high levels of share buybacks due to be announced in the coming weeks.
As such, after a difficult October, equity markets could be in for a more traditional Santa rally in the run-up to December.
A stabilised economy
More practically, the risk of additional deficit spending looks limited as Democrats are now able to block further unfunded expenditure. This reduces the likelihood of an overheating economy and potential for faster than expected tightening from the US Federal Reserve in response.
The expectation for further tax cuts also appears dead in the water, however, as does big investment in infrastructure spending.
Though improving infrastructure has been a key Democrat commitment in previous elections, they will be reluctant to let President Trump get the credit for such initiatives as he heads into the 2020 presidential elections.
While this outlook may prevent another tax cut-style rally, it is by no means a negative for US equity portfolios. A more predictable path for interest rates provides stability for discount rates and, as a result, valuations – a scenario which would likely be derailed by further fiscal largesse.
A lame duck?
Aside from the above, the bigger question for markets now will be just how President Trump will rule as very few expect him to settle for being a ‘lame duck’ President.
Seeking compromise with Democrats may be the preferable path for investors. This creates the potential for targeted spending deals and reduces risks around government shutdowns.
If President Trump seeks to force things using his executive powers, however, we will likely see blocking tactics from Democrats and even greater tension between factions.
In the latter scenario President Trump may direct his attention towards areas he has more influence over, such as foreign policy. This could lead to an increase in trade war rhetoric and while emerging markets have borne the brunt of this so far, there are no real winners here in the long run.
One other area of control is the judiciary, particularly in light of the recent controversial confirmation of Brett Kavanaugh. The risk to markets here would be much more unpredictable in terms of individual stocks or sectors meaning a careful eye and local market knowledge will be essential to avoiding shocks or capturing opportunities.
Across the board it is difficult to predict the direction of US politics over the next two years, much less the impact it will have on investment at a global level.
However, one point remains clear – the importance of keeping a calm head and a steady hand throughout will be key to riding out the wave.
Scott Osborne is investment analyst at Brown Shipley
