Wednesday, 7 November 2018

CAUTIOUS MOOD AHEAD OF U.S. MIDTERM ELECTIONS

Investors across the globe are keeping a close eye on today’s most expensive U.S. mid-term election on record. In less than 24 hours, American voters will have their say on how well they think President Trump has handled running the country. The three possible scenarios are a red wall, a blue wave, or a gridlock. But what markets have priced in so far is for Democrats to take control of the House of Representatives while Republicans to remain holding the Senate.

The combination of a Republican President and a split Congress have produced an average return of 15.7% on the S&P 500 in the 12 months following every mid-term election since 1950. These strong returns suggest that investors prefer a gridlock, a situation when different political parties control the two legislative houses. While such anomalies are difficult to explain, investors may find that a gridlock produces more predictable political outcomes to model and value equities against.  In the case of a gridlock, Democrats cannot roll back recent tax cuts, neither they can tighten the Dodd-Frank banking rules. It may just mean that Trump will face more difficulties in passing new laws.

However, in the current tense environment it seems Wall Street will prefer Republicans to retain both legislative houses. That’s simply because a new tax cut will be expected to take place, further deregulation, and probably additional fiscal stimulus. While such measures are not necessarily good for the longer run as deficit and debt may get out of control, many investors will take advantage of these policies in the shorter run. Given that the polling industry got it wrong in 2016 and Trump became President, history may repeat itself this time again.

It would be more surprising if Democrats managed to win both houses. This will be a nightmare for Wall Street, as the Trump impeachment threat will become more real, but still, this would require help from some Republicans. Even if he doesn’t get impeached, the President will no longer have the power to pass bills and probably lead to pulling back some of his deregulatory actions, which definitely is not liked by corporate America.