In last month’s Perspectives newsletter, we detailed expectations, as well as probable and possible outcomes heading into midterm elections. The article: “Democrats or Republicans…Who Will Ace the Midterms” is available here for your reference.
Midterm Outcomes Aligned with Expectations
Yesterday, Americans cast ballots to elect members for all 435 seats in the House of Representatives and 35 of 100 seats in the US Senate. Stakes were high. Republicans sought to maintain control of both Houses and Democrats attempted to shift the balance of power. Polls predicted Democrats would gain control of the House, while Republicans would retain control of the Senate. This was indeed the outcome.
Not every congressional seat has been officially declared as of this writing, but it is clear that Conservatives gave up at least 25 seats and control of the House of Representatives, while retaining control of the Senate with at least 51 seats accounted for.
Midterm outcomes had the potential to either validate the administration’s legislative agenda, or to appeal for a higher degree of checks and balances. We anticipate control of the House likely prioritizes two key agenda items for Democrats: 1) oversight and pursuit of investigations into aspects of the Trump administration, previously blocked by the Republican majority; and 2) reversal of key provisions of the recent tax overhaul.
Most will conclude that a divided Congress translates to two years of legislative gridlock, the accompanying certainty of which would be a positive for financial markets. There is also a view that divided government presents an opportunity for productive negotiation between parties in order to successfully move significant legislation forward, though recent attempts at such collaboration have been largely unsuccessful.
Financial markets frequently pull back in the weeks leading into midterms and often rally in the months following election results. Uncertainty tends to intimidate investors, while certainty (regardless of outcome) can be reassuring.
On the front end of that pattern, October 2018 did not disappoint. The S&P 500 gave back nearly 7%, erasing year-to-date gains and marking the single worst month since September 2011. That said, the approaching midterms may have been more coincidental than causational as concerns related to global growth, corporate earnings, and rising interest rates took their toll on virtually all major asset classes last month. The market’s rebound off of October lows in the days leading up to elections further supports our view that the midterms themselves had relatively little to do with recent market fluctuations.
This morning, equity markets are poised to open modestly higher in what appears to be an orderly reaction to midterm outcomes. We will be watching for continued stabilization as markets digest the election results and retrain their focus to forecasting the impact on economic and corporate fundamentals.
During this election cycle we have taken the opportunity to highlight that our investment philosophy is predicated on evaluating fundamental characteristics. We place less emphasis on technical analyses, such as how markets have traded before and after prior elections. We tend to believe that fundamental characteristics like asset class valuations, economic growth and inflation, and demographics are better predictors of long-term asset class returns. We acknowledge that the Federal government may impact these characteristics, but the impact is both difficult to predict and difficult to quantify ex-ante.
From our perspective very little has changed in recent weeks. We are late in the cycle, but economic fundamentals remain sound and we believe the likelihood of a recession in the next 12 months remains low. Through the end of the year, we will be paying close attention to Federal Reserve posturing and the evolving dialogue between the US and global trading partners as we refine our outlook heading into 2019.
Please contact any member of the Greenleaf Trust team with questions.