WHAT THE MIDTERMS MEAN FOR THE MARKET
Sadiq S. Adatia, Chief Investment Officer
AlyKhan Somani, Associate Portfolio Manager
Opinions as of November 9, 2018
The results of the U.S. midterm elections were broadly in line with analyst expectations with the Democrats making major gains and regaining control of the House of Representatives after eight years, while Republicans continue to hold a Senate majority. Democrats claimed at least 30 additional House seats on the strength of their support in previously held Republican metropolitan areas, in states such as Georgia and Florida. Additionally, approximately two-thirds of Democratic wins came in suburban districts of cities such as Philadelphia, Washington and Miami – after years of voting Republican – partly thanks to a surge in support among women. Republican votes, on the other hand, stemmed primarily from blue-collar, rural parts of the U.S. where Trump’s approval ratings have stayed the strongest.
In the Senate, Republicans added to their one-seat majority by winning Democratic seats in Florida, Indiana, North Dakota and Missouri while narrowly retaining Republican Senator Ted Cruz’s district in Texas. For their part, Democrats fared poorly in Senate races in traditionally Republican states, including Utah and Wyoming, thanks in part to Trump’s decision to campaign in some of those states, and the impact on Republican sentiment from Brett Kavanaugh’s bitterly contested nomination to the Supreme Court.
Democratic House Seats*
The elections show an increasingly polarized America where populations in large cities and many of their suburbs lean blue, particularly among higher-educated women and immigrants. On the other hand, blue-collar workers and populations in rural areas, including rust-belt backwaters, continue to be strong GOP supporters. We do not anticipate this changing in the near future and believe it will be difficult for either party to gain a majority in both houses of Congress in 2020.
Republican Senate Seats*
What this means for interest rates, growth and future stimulus
At a high level, outside of potential infrastructure and defense spending (which both have some bipartisan support) as well as some changes to immigration and trade (for which President Trump could avoid involving Congress), there may not be much in the way of federal policy changes until 2020.
On the fiscal/trade front: a wall, China and infrastructure
- If an infrastructure stimulus package makes it through Congress, it may be quite small.
- Tax and major regulatory changes made to date are safe for now as changes will not get bipartisan support and the President maintains veto power. However, further major deregulation efforts in the energy sector will be more difficult to achieve, potentially hurting Canadian business interests.
- U.S.-China trade relations should not change as Congressional support for better trade terms with China is a bipartisan issue and Trump can act without Congress.
- The USMCA will be marginally harder to pass under a Democratic House but should still pass.
- Trump’s desire for a wall on the Mexican border could trigger a government shutdown as the debt-ceiling limit expires in March of 2019.
On the political front: tax returns, collusion and partisan anger
- With Republicans holding a Senate majority, Trump will be able to continue making cabinet and judicial appointments, including to the Supreme Court.
- Trump will face more scrutiny on potential collusion with Russia, particularly with the resignation of Attorney General Jeff Sessions.
- The President’s tax returns and financial records could be sought by the House, and administration officials required to testify under oath.
Market impact today and future expectations
Markets responded positively to the election results. Initially, equities rallied sharply while bonds were little changed and the U.S. dollar weakened. The strong chance that there will be no major policy changes during the remainder of Trump’s first term is something most investors may be comfortable with – especially as Congressional gridlock has not impeded a strong U.S. economy in the past.
We view the results of the midterm election that produced a mixed Congress to be less equity friendly than a Republican-led Congress, with reduced stimulus in the future from increased government spending, easing of regulations and taxes.
The “Trump put” won’t be as strong with Republicans no longer having a Congressional majority to enact fiscal policy changes. But this could be constructive for the U.S. government’s balance sheet and thereby positive for U.S. bonds. Between a weaker story for U.S. stocks and slightly stronger picture for U.S. bonds, we view the election result as a bit less friendly for the U.S. dollar.
Positioning the Granite portfolios before the election
Going into the elections the Sun Life Granite Managed Portfolios were slightly overweight equities, with a tilt toward U.S. stocks. They also maintained a small overweight to high-quality U.S. bonds. Additionally, the Granite Portfolios held multiple risk-reducing option positions via the Sun Life Granite Tactical Completion Fund on instruments such as the VIX, S&P 500 and U.S. treasuries. Potential upside, via opportunistic option positions on emerging markets and the Nasdaq, were also held to take advantage of a potential recovery in equity markets.
With the election behind us, we are still positive on the U.S. albeit less so. Trump could become tougher with China in the near term. As a result, we have maintained our risk-reducing option positions, but have reduced our equity position to neutral while maintaining upside option exposures in case of progress at the G20 meeting later this month.
For now we’re watching for pressures on emerging markets, and possible spillover effects as the impact of U.S. fiscal stimulus peaks. We are also tracking the U.S. Federal Reserve as it continues to tighten as well as the prospect of business conditions weakening in response to the U.S./China tariff battle.
And we will continue to monitor economic conditions and adjust the portfolio to reflect our current views.
*Source: Expected results based on PredictIt.com opinion on Nov.5. PredictIt, located in Washington D.C,. is a “stock market for politics,” in which investors can buy shares for or against an event taking place. It is used to study the efficacy and value of markets in predicting future outcomes.
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© Sun Life Global Investments (Canada) Inc., 2018. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.