Wednesday, November 7, 2018

Investment Implications of Midterm Election Results

History shows that economy and Federal Reserve monetary policy are much more important to investors than politics, and incoming U.S. economic data remains encouraging.
As anticipated by the consensus, Democrats took control of the House of Representatives, while Republicans retained their control of the Senate. We see a limited impact on financial markets as a consequence of the midterms. These results set the stage for two years of legislative gridlock, which has historically tended to benefit equities.

Meanwhile, President Trump’s pro-business economic policies of deregulation, tax cuts, and fiscal stimulus will remain in place. The President and the Democrats could work together to boost infrastructure spending, while the election results will do little to alter Trump’s trade protectionist agenda.

This outcome is the gridlock scenario that the consensus expected and investors should not expect a lot to get done over the next two years. However, there are some issues that Trump and Democrats agree on and some legislation that matters to investors is likely to pass into law.

Infrastructure spending is a priority for Democrats and Trump and is an area of potential agreement. Democrats will likely make drug price controls a major issue. If Trump embraces their proposals, legislation could pass in the Senate. This would be a negative for pharmaceutical and biotech companies. They both favor a higher minimum wage, which would be negative for restaurants and retailers.

While the U.S.-Mexico-Canada Agreement (USMCA or NAFTA 2.0) will likely face additional uncertainty for implementation, it should ultimately be passed. Congress has limited power to restrain the President on trade policy and we don’t expect the election results to have a material bearing on the China trade conflict. Many Democrats are also in agreement with the President’s stance on China’s trade and intellectual property practices. We anticipate that President Trump will continue escalating trade sanctions against China unless that country addresses its unfair trade practices.

Since President Trump took office, deregulation and regulatory freezes have been very positive for business and investor optimism (the number of economically significant rules declined by the largest amount since the federal government has been keeping track). Most of the deregulatory activities under Trump have occurred through executive action, not legislative, and these should continue regardless of the midterm election outcome.

Importantly, last year’s pro-business tax bill, which dropped the corporate tax rate from 35% to 21% and gave major incentives for business investment, will also remain in place.

Major beneficiaries of the current pro-business, de-regulatory environment include small cap stocks and banks. Trump has favored traditional energy companies and the oil and gas industry and coal should continue to benefit from a favorable policy environment. Defense companies, which benefited from recent budget agreements, should continue to benefit from future funding.

Despite the prospect of political gridlock, history shows that the economy and Federal Reserve monetary policy are much more important for investors than politics – and we remain positive on the economic outlook. The incoming U.S. economic data remains encouraging while third quarter corporate profits are coming in at a very healthy 26% growth rate. This provides a positive backdrop for further stock market gains.

Michael J. Halloran, CFA
Strategy Analyst, ISG
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Mr. Halloran serves as a Strategy Analyst in Janney’s Investment Strategy Group. Bringing over 15 years of financial service experience to Janney’s established team of professionals, Mr. Halloran analyzes all asset classes with particular emphasis on equity research.

Prior to Janney, Mr. Halloran was Vice President of Market Strategy for BPU Investment Management Group, and was responsible for the development of the firm’s global outlook and implementation of numerous investment strategies. His previous experience includes performing equity research for large cap core and growth mutual funds, and working in PNC’s investment banking organization supporting M&A, high yield, private placement, loan syndication and derivative security transactions. He is also an adjunct finance professor and former aerospace research engineer.

Mr. Halloran received his B.S. in Mechanical Engineering from the University of Pittsburgh, M.B.A. from Carnegie Mellon University and his M.S. in Mechanical Engineering from the University of Florida. He also holds the Chartered Financial Analyst (CFA) designation.

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