Investors urged to avoid overreaction to midterm result
The final count of US votes is in. Control of Congress is now split between the Democrats – who now hold a majority in the House of Representatives – and the Republicans, who increased their Senate majority.
The final count of US votes is in. Control of Congress is now split between the Democrats – who now hold a majority in the House of Representatives – and the Republicans, who increased their Senate majority.
As political commentary goes into overdrive, and American stock markets post gains of more than 2 per cent, investors may be wondering how best to respond.
Do you sell US stocks? Buy corporate bonds - or both? Or neither? What about your emerging market exposures?
Morningstar's director of policy research in the US, Aron Szapiro, emphasises caution. Readers who have followed our commentary around other major political events will recognise a familiar refrain: "it would really be a mistake to overreact".
Szapiro says Americans should follow these events closely "in their role as citizens", but not so much as investors.
From a legislative perspective, he says the ongoing investigations into alleged Russian collusion and election manipulation is likely to be a focus for the Democrats in taking a House majority.
But whether that – or the resignation of attorney-general Jeff Sessions overnight - has an explicit effect on markets is debatable.
Investors shouldn't overreact to the financial press at such times
"There's just not that much day-to-day connection between investigations and the business of governing,” Szapiro says. “A lot of the agencies that make policy that directly affect investors, like the Securities and Exchange Commission, are really quite independent and somewhat insulated from this kind of day-to-day machinations.
"I would say investors should stick to their strategy and not worry too much about the day-to-day information on investigations or the tweets back and forth or whatever else.”
While Szapiro talks about implications for people in the US – such as potential changes to the retirement saving system – he sees no tangible, long-lasting global market effects.
In terms of specific sectors – manufacturing, infrastructure and healthcare came under tight scrutiny when Trump took office in November 2016 – Szapiro points to a potential of a deal on infrastructure.
"We've been hearing that for some time, so I'm a little sceptical, but if there were a big infrastructure bill that was able to find purchase in the House and get through the Senate, that would first of all signal a much more bipartisan style of governing than I think is generally the common wisdom.”
While he says this would "probably provide a fairly meaningful short-term stimulus and long-term help for the economy," and he is keeping an eye on it, "I don't think it's a hugely likely probability".
‘Divided government nothing new’
Turning to external industry commentators, Vincent Reinhart Chief Economist at BNY Mellon's Standish, and a former Federal Open Market Committee economist, says a "divided government is nothing new in the US experience".
However, he says the result will allow the Democrats to apply the blowtorch to Trump’s personal affairs, particularly his tax returns.
"In 50 years over the past century, the levers of power of the President, House and Senate were split between the two parties. This, however, will be an extremely divided government over the next two years.
"The Democratic leadership in the House will direct various committees to launch investigations of the President’s performance, re-litigate appointments and pressure agency heads to walk back their deregulation efforts. Included in that will be the release of President Trump’s tax returns which will be sure to generate both unfavourable headlines and White House antipathy.
He believes it is unlikely that any bill will get signed into law. "Showy legislation from the House giving Democrats the opportunity to erect their platform for the 2020 election will die in the Republican Senate.
"However, cohesion on the Republican side may break down, as more than a few members look toward that election as well.”
Headwind for economic activity
Despite the political divisions, Reinhart says the markets will welcome some degree of certainty. But he sees a potential "setback" for business investment, especially in capital-intensive energy sector projects, where there is wide policy divergence between Democrats and Republicans.
"Second, if the president is even more assertive on trade and immigration, there is some risk that tariffs and restrictions will pose an adverse cost shock to the US economy,” Reinhart says.
"These forces combine to slow economic growth, likely leading the Federal Reserve to trim back its rate hiking intentions and prompting investors to be more wary about risk.”
One immediate beneficiary of the midterm result could be US infrastructure, according to Jim Lydotes, senior portfolio manager, global infrastructure, BNY Mellon Investment Management.
"We are not pegging our story to a huge revival of US infrastructure, but with a better balance of power we could emerge with a legitimate infrastructure investment plan,” Lydotes says.
"Markets have been weak and President Trump may be getting nervous. However, declining markets can often be economic stimulants. With a better balance of power, even with a little bit of confused malaise in equity markets, a stable infrastructure plan can be a good way of invigorating the domestic economy.”
Infrastructure a priority for both camps
And while this result offers little for investors to consider in the short term, we may look back on it as providing impetus to domestic growth, says Paras Anand, head of asset management, Asia Pacific at Fidelity International.
“Part of the reason for the post 2016 election ‘Trump bump’ was the belief that the economic agenda would be domestically focused, particularly on infrastructure investment," Anand says.
He notes that spending on infrastructure also ranked highly on the policy agenda of Trump’s Democratic rival, Hillary Clinton.
"It is possible that with a bi-partisan focus on the pent-up need for domestic infrastructure investment, the Democrat view on the budget deficit may change from opposition (to tax cuts) to accommodation (spend on roads, hospitals, airports),” Anand says.
"Any development in this direction would further spur the overall economy, continue to push wages in an already tight labour market and potentially challenge the current expectations around Fed activity for next year.”
And while Morningstar’s Szapiro sees the result as having little effect in the short term, Anand, in contrast, wonders: "Most political events have underwhelming economic impact - could the US midterms prove the exception?”
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Glenn Freeman is senior editor at Morningstar Australia.
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