Market Comment - US midterms: Democrats take the House providing a check on Trump

News item -

It is finally over. The US midterms, which have been widely viewed as a referendum on US President Donald Trump, have concluded. The Democratic party has taken over the House of Representatives and Donald Trump’s Republican party retained the majority in the Senate.

All 435 House seats were up for election, while only 33 out of the 100 Senate seats were in play. In the House, the Democrats are expected to have gained as many as 35 seats, when they needed just 23 to take the majority. In the Senate, the ratio of Republicans to Democrats had been 51 to 49. Final results of all the races are not yet known, but it is already clear that the Republicans have not only maintained their majority in the Senate, but also likely gained a couple seats there.

Outcome was expected

This outcome was widely expected and was also our base-case scenario. Midterm elections occurring after a presidential election frequently see the opposite party to the president making gains, especially in the House of Representatives. Americans appear to be more comfortable with a divided government over one party dominating. But more than in the past, this election was seen as a reaction to Trump -- both for and against. This also explains the high voter turnout compared to previous midterm elections.

With a divided Congress, Trump will have a much more difficult course in implementing his agenda. His presidency will also likely be stalled by subpoenas and investigations, now that the Democrats have gained the majority in the House. Impeachment of the president is also possible, as any impeachment measures must be first introduced in the House. But unless the ongoing investigation by Special Counsel Robert Mueller on Russian interference in the 2016 presidential election provides extremely compelling evidence, it is very unlikely that an impeachment confirmation by the Senate would be forthcoming.

Fiscal stimulus will fade next year but fundamentals are strong

The House of Representatives is singularly responsible for introducing all legislation affecting revenues and taxes. With Democrats in charge, Trump will have much more difficulty in passing more fiscal stimulus measures or further tax reform measures. Fading fiscal stimulus was already a component of our outlook for 2019.

We expect that US economic growth will slow next year, as economic growth shifts from 3% in 2018 to 2.7% in 2019. Nonetheless, fundamentals remain solid. Business confidence in the manufacturing sector, for example, remains strong and consumer confidence is high. US households are in good shape, and we expect that growth in consumer spending will remain firm in the quarters ahead.

Fed will continue hiking rates

The US Federal Reserve has been on a well signalled path to hike rates. We expect that this will continue with three more 25 basis-point hikes over the next few quarters. This is based on the continuation of above-potential economic growth, high employment and low inflation. We are expecting one hike less than the Fed itself in 2019, and we also believe that longer-term US rates are close to their peak.

Impact on the trade war with China

We do not expect that the new political landscape will lead to major changes in Trump’s stance towards China. Most of his decisions here are part of the President’s executive power and particularly the steps taken towards China will also find support with Democrats. One of Donald Trump’s very last announcements in the lead up to the midterms was that his staff was working on a ceasefire with China on the trade conflict. While this is a positive sign, we are sceptical that a significant truce will be brokered at this stage. Trade tensions could persist into 2019.

What should investors do?

Markets have already been volatile, responding to US and European politics, the ratcheting up of the trade disagreement between the US and China and the turmoil in emerging markets. We do not expect today’s election results to have much effect, as it was widely expected.

We believe that US will continue to dominate the global economy next year and that US companies will benefit from the existing positive economic fundamentals. We continue to favour the US over other regions in terms of stock investing, based on potential earnings growth. This is supported by strong earnings reports in the US, where most companies reported higher-than-expected earnings in the third quarter.

Richard de Groot
Global Head Investment Centre