The Democrats flipped the House, the GOP gained seats in the Senate, and the Dow jumped. Why?
With Nancy Pelosi and the Democrats taking control of the House, investors shouldn’t expect new tax cuts – but that may actually be good news for the stock market.
What do the 2018 midterm elections mean for the stock market and the economy? With Republicans losing control of the House, what are the short- and long-term implications?
The GOP added to its Senate majority, but the most notable change on Capitol Hill will be the newly blue House of Representatives, which, beginning in 2019, will wield a Democratic majority for the first time since early 2011.
The characterization of the stock market as a sort of fickle, paranoid proxy for U.S. investors, however insulting, proves itself true time and time again. America, uncertain of how she would vote, breathed a sigh of relief once she saw the results.
On Wednesday, the Dow rose 545 points.
In Wall Street terms, the election “de-risked” the market. Here are five major takeaways for investors following the 2018 midterms, several of which contributed directly to Wednesday’s impressive rally.
Tax 2.0 would not have been positive – and it’s not happening. In the weeks leading up to Nov. 6, President Donald Trump suddenly began teasing another round of tax cuts – dubbed Tax 2.0 – more squarely aimed at the middle class. The biggest benefits in the 2017 tax cut bill went to corporate America.
With Democrats helming the House, new tax cuts are even less likely to occur. And that, it turns out, is actually good news for the stock market. “Tax 2.0 would not have been that positive because you would be stimulating what is an already strong economy,” says Dec Mullarkey, managing director of investment strategy at Sun Life Investment Management.
That acceleration would’ve forced the Federal Reserve to raise interest rates at an even steeper pace, Mullarkey says, which over time puts the brakes on economic expansion. With a divided Congress ruling out that possibility, “At this point I think we’re in a better state of actually having more sustainable growth for a period,” Mullarkey says.
Impeachment is unlikely. While many investors may be tempted to look at the 2018 midterms through the lens of what has changed, and a Democratic House is the headline switch-up, experts across the board emphasize the gravity of what hasn’t changed.
“Congressional investigations [into Trump] will ramp up, but it’s important to look at it from an impeachment perspective,” says Jeffrey Schulze, investment strategist for ClearBridge Investments, a New York-based affiliate of Legg Mason. “Impeachment would set markets off,” Mullarkey says. “The likelihood of impeachment right now is very low,” Schulze says, noting that even if the House impeaches Trump, a supermajority of 67 votes is needed in the Senate to oust a president.
Though Dems never had a chance to control that many seats in the 100-person body, if the Senate had even gone blue by a slim margin, markets would’ve had to factor in the specter of impeachment far more heavily.
And remember how repulsed Wall Street is by the “u” word: uncertainty.
Sector winners and losers. For a market that acts like it’s practically vanquished uncertainty, there’s still a conspicuous lack of consensus about which sectors will outperform or what are the best stocks to buy.
A divided Congress “generally maintains the status quo. But I do think health care in particular benefits,” Mullarkey says. “Neither side can repeal or improve (the Affordable Care Act).
“The one area I think could be hurt a little bit would be biotech and pharmaceuticals … there’ll be a push to do something with drug pricing,” Mullarkey says.
It’s true that Democrats have long lobbied for lower drug prices, and, at least according to Trump’s 2016 campaign rhetoric, the president is fully on board with that. Schulze, on the other hand, doesn’t think drug price controls are realistic, and is emphatically bullish on biopharma. “For only the third time in 25 years biopharmaceuticals are trading at a cheaper valuation than the overall market.”
He also thinks a GOP-contr
olled Senate tells you something important about tech. “Communication services could rerate higher with net neutrality off the table,” Schulze says. Other sectors like materials and industrials would theoretically be big winners if a sweeping bipartisan infrastructure bill were passed, but in modern-day Washington, infrastructure bills of that size typically fail before they get off the ground, plagued by horse-trading, lobbying and local versus federal government quarrels, Mullarkey says.
Less is more. In 1686, Isaac Newton published his three laws of motion, the first of which applies to far more than fly balls: objects in motion stay in motion unless acted upon by an outside force. This law, inertia, is a property of matter, and markets.
The split Congress virtually guarantees a state of gridlock on Capitol Hill between 2019 and 2021. Which, for Wall Street, is perceived as a positive. “Historically when Congress is tied up they can’t mess around with business too much – and so that’s one of the main reasons the stock market does like this,” says John Vail, chief global strategist at Nikko Asset Management.
“People always say the stock market doesn’t like uncertainty,” Vail says. “And there’s a lot of certainty that nothing will get done. “When the economy needs help, that’s bad; when things are going reasonably well, no government interference is fine.”
Tariff impact, geopolitical risks ahead in 2019-2020.
The last thing to take away from the 2018 midterm elections might not be readily apparent from Wednesday’s 545-point buying spree in the Dow. A split Congress likely means less domestic wins for the president in his last two years, which means Trump will be looking for wins elsewhere. “To show progress in the next two years as he’s running for re-election, I think he’s going to get much tougher on trade with China, and I think he’s also going to get tough on Iran,” Mullarkey says.
Mullarkey believes Trump could try to drag those issues out to dominate the news cycle and rile up his base. “And I think that’s going to create a fair bit of volatility from geopolitical risk,” Mullarkey says.
Schulze also thinks the trade war risk is smaller in the near term, citing $1 trillion in fiscal stimulus from tax cuts, repatriation and a budget bill. “What does get me nervous is once we get closer to 2020, the economy won’t have that stimulus filtering through its veins,” Schulze says. “And we may be a little bit more vulnerable to a downturn from tariffs.”
By John Divine, Staff Writer Nov. 8, 2018, at 1:39 p.m.