US midterms – what now?

It was, as expected, an uneventful night, and while Democrats have the House back under their control, the Republicans have increased their hold on the Senate.

US flag
Source: Bloomberg

While the president might view it as a ‘tremendous’ success, and taking seats in the Senate as the incumbent party is certainly an achievement, the loss of the House will make life more difficult from a legislative perspective. However, the Democrats cannot block the president’s entire agenda, as they might have been able to do with control of the entire Congress.

The result will have some hoping that an impeachment is more likely, but even with control of both it would still be difficult, and with only the lower house in their possession only an open and shut case of malfeasance would really energise such a move.

Still, the Republicans will have a much tougher time pushing on with their agenda. Increased infrastructure spending is now less likely, since the two sides will be unlikely to agree on how the money is to be spent, and the potential for a middle-class tax cut is much reduced. Democrats wishing to burnish their fiscal responsibility credentials will not look kindly on tax cuts, but they need to tread carefully since opposition to such a move would give US President Donald Trump a stick to beat them with in 2020.

The trade war rhetoric could well continue, although the need to play to his base is now much reduced, at least for a year or so. But Mr Trump is still likely to pile the pressure on Beijing, given evidence that the Chinese economy is feeling the pressure. Trade wars are an area where he can utilise his executive powers, so the midterm result changes little. But he will find it tough to broaden out the conflict to include the EU, and instead the Democrats may push the White House to find a compromise with Europe that allows them to present a united front against China.

A divided Congress does raise the prospect of a return to the government shutdowns that peppered the Barack Obama era. Both sides seem happy to spend, but on different things, so some late-night deadlines and last minute quick fixes are likely. Criticism of the Federal Reserve (Fed) is not going away, but with the Republicans having lost control of the lower house it will be harder to push through any new appointments to the Fed of more compliant officials.

The market has taken the result in a positive frame of mind, perhaps because fears of a big increase in US debt have been reduced, while a more conciliatory approach on trade wars could help boost global growth. Equities do well in the wake of midterms, with every 12-month period following the midterms since World War Two (WW2) being positive for equities.

A divided house has also been historically good for equities, with an average return of over 17% for the S&P 500 for the following 12 months after a midterm result such as we saw last night. Earnings season has been mixed, but as the market has recovered the number of positive reactions has increased; earlier in October the reaction was ‘sell the news’, but now it is ‘buy the fact’.

Investors will be relieved to get the political drama out of the way and focus on the underlying economy and equity performance. Both are encouraging and with wage numbers on the rise again the prospects of higher consumption in the US seems likely. While fears remain, the midterms have not produced any terrible shock, suggesting that there is still scope for the usual end of year bounce we see in equities.

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