U.S. midterms update: Democrats take House, Republicans keep Senate. Markets react.
Editor’s note: This blog has been updated to include initial reaction from markets on Nov. 7.
In a widely-expected outcome1, U.S. midterm elections concluded with the Democrats gaining a majority in the House of Representatives, while the Republicans maintained control of the Senate.
The initial reaction from markets has been largely positive, with the Dow Jones Industrial Average advancing roughly 180 points, the S&P 500® Index climbing approximately 1% and the MSCI All Country World Index gaining 0.8%, as of 7:30 a.m. Pacific time on Nov. 7. The UK’s FTSE 100 was also up about 1%. In Japan, the Nikkei 225 Index was off just slightly—down 0.3% from its Nov. 6 close.
Why the mostly positive reaction? As we discussed last month, the top pro-growth items of the Trump administration—fiscal stimulus, February's budget agreement and a spate of regulatory reform measures—have already been signed into law. The bar to unwind any of these measures is now officially un-achievable: a two-thirds Democratic majority in both the House and Senate would have been needed to pass new legislation doing away with any or all of this (in order to survive a near-certain veto from President Trump).
Secondly, markets dislike uncertainty—and the outcome of yesterday's elections was very much in line with most projections. In other words, certainty ruled the day. Had the unlikelier scenario of a Democratic takeover of both the House and the Senate won out, we think markets likely would have declined in more significant fashion in the days ahead.
However, this is not to say that a change in the ruling makeup of Congress—Democrats will now control the House for the first time in four years—won't cause volatility in markets going forward. We believe that there are now three second-order considerations at play—policies or events that investors are likely to pay careful attention to now that the House has changed hands. Depending on the outcome of each, some additional market noise is possible.
- Trade wars
- Infrastructure investment
With the House under Democratic control, we believe there is a chance (however unlikely) that impeachment charges could be brought against President Trump sometime next year. While this is not central to our investment thesis, we do see it as a possibility—one that may increase in likelihood depending on the conclusion of the Mueller probe. Should Democratic leadership take up impeachment proceedings, a simple majority vote within the House is all that is needed to formally impeach President Trump. With a Democratic majority come January, this scenario cannot be ruled out.
Bear in mind, however, that impeachment strictly means charging a high-ranking government official with misconduct—rather than removing that official from office. The responsibility of removal falls to the Senate, where a two-thirds majority is needed following a trial—otherwise, that person is acquitted. With Republicans maintaining control of the Senate, we believe it's highly unlikely that President Trump would face the threat of removal from office, should the House formally impeach him.
However, the act of impeachment alone could create noise in markets—although we don't see any potential decline (or bounce) as long-lasting. Why? Generally speaking, it's changes in economic and corporate earnings fundamentals that drive volatility in markets—and not the other way around. The impeachment of President Bill Clinton in December 1998 provides a telling example of this: Stocks actually climbed during this period, after bottoming out earlier in the fall2. Why? The U.S. economy was humming along and the dot-com boom was in full swing—issues of greater importance to markets.
If House Democrats do decide to move forward with impeachment charges against Trump, we think this could influence, to a degree, the president's trade-war rhetoric. Since last March, Trump has made what he views as unfair trade arrangements between the U.S. and a host of other countries a centerpiece of his administration's agenda. While a deal has been struck between the U.S., Canada and Mexico, the situation between the U.S. and China is far from resolved—with current U.S. tariffs of 10% on $200 billion of Chinese products set to jump to 25% on Jan. 1.
This is where a potential impeachment charge could come into play. The noise surrounding the process could cause Trump to shift his focus from trade and protectionism in general. Were this to happen, markets would almost certainly breathe a sigh of relief, given the degree to which they've been rattled by the president's tough talk on trade this year. That being said, we view the upcoming G20 meeting in Argentina as a far more important milestone, watch point, and consideration for U.S.-China trade policy than the midterms.
The Trump administration has touted improvements to the nation's infrastructure as a priority3, but announced back in March that any efforts to move forward on a sweeping overhaul would be put on hold until after the midterms4. Now, with that day here and a more divided Congress looming come January, we think that any efforts on this end will probably get tied up in partisan gridlock. While both Republicans and Democrats have indicated eagerness to pursue an infrastructure revamp, there's been no agreement among party leaders on how to shoulder the cost. With polarization looming large for the 116th Congress, we see a deal on infrastructure as less likely than before. Given its pro-growth undertones, markets would probably respond positively to an infrastructure package (which Trump would likely sign), on the off-chance that both parties are able to reach an agreement.
While we expect some short-term ups and downs in markets over the next few weeks, we believe that a lack of worry among investors over any potential changes to the pro-growth measures advanced by the Trump administration will result in minimal market reaction in the days ahead. Put another way, when it comes to Trump, the Republican party and markets, what's done has been done. Going forward, we expect that any significant volatility in markets will be driven largely by changes in economic data points, trade or rate increases by the U.S. Federal Reserve.
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1 Source: https://projects.fivethirtyeight.com/2018-midterm-election-forecast/senate/?ex_cid=midterms-header. As of Nov. 2, 2018
https://projects.fivethirtyeight.com/2018-midterm-election-forecast/house/?ex_cid=midterms-header. As of Nov. 2, 2018
2 Source: https://www.marketwatch.com/story/stock-market-rally-could-keep-chugging-even-if-trump-were-impeached-2018-08-28
3 Source: https://www.cnbc.com/2018/02/12/trumps-plan-for-us-infrastructure-spending-faces-steep-hurdles.html
4 Source: https://www.cnbc.com/2018/03/29/trump-infrastructure-plan-will-likely-wait-until-after-the-midterms.html