The most momentous midterm elections many of us have ever experienced are (almost) over (at press time, several races were still too close to call). It’s never easy to say exactly what it all means so soon after the results are in, and these politically fraught times make it even less so. Still, it’s possible to outline the political landscape that may emerge and predict what effects it could have on the market and investments.
This is certain: as of Jan. 3, 2019, the House of Representatives will be run by the Democrats and the Senate by the Republicans. President Trump now has to deal with a divided government and determine what role he wants to play: compromising dealmaker or pugnacious up-ender of political tradition. Note that this is the position that Senate Republicans and House Democrats are in as well. This may indicate total legislative gridlock until January 2021, with nothing being done; but it may also lead to some significant accomplishments, as there are possibilities for bipartisan action. From an investment perspective, legislative gridlock–as long as it does not shut down the government–should not cause market turmoil. Legislative action could create uncertainty, which is what roils markets, whereas gridlock is nothing if not the certainty of the status quo.
President Trump, who prides himself on being a dealmaker, may find gridlock intolerable. He has indicated that he is willing to work with Democrats in areas where they can agree; still, there are several factors that make such compromise unpredictable, not the least of which is the president’s mercurial nature. He has already struck a conciliatory tone and come close to making deals with Democratic leaders on immigration and government funding, only to back away from sealing an actual agreement. Still, that may have been the influence of those in the White House who saw themselves as handlers. There may be fewer handlers now, as Trump asserts himself and puts an even more personal stamp on his administration. But the president’s desire to compromise on, say, infrastructure and healthcare may lead to gridlock when opposed by his own party, putting his self-proclaimed ability as a dealmaker to the test as he will have to push Senate Republicans to fall in line.
Having to deal with a Democratic House may push Trump away from his more Trumpian behavior of breaking longstanding political norms and into some oft-predicted-yet-not-realized traditional presidential behavior. But any White House deals with the Democrats must also pass through a Senate that is now more Republican, after an election that proved the party is nothing if not solidly Trumpian. Sen.-elect Marsha Blackburn of Tennessee, a longtime Tea Party favorite and Trump ally, replaces staunch Republican Trump critic Bob Corker. Newly-elected Republican senators Mike Braun of Indiana, Kevin Cramer of North Dakota, and Josh Hawley of Missouri replace Democrats; all sought to model themselves on Trump. The question now is: how much more Trumpian than Trump will the Senate be? If voters backed their candidate on the premise of no compromises, will the president have the influence to move the Senate in the other direction? One bellwether will be Sen.-elect Mitt Romney of Utah, who has been a Trump critic in the past, and represents a red state that has been less enthusiastic in its support of the president than others. If Trump begins to turn to Romney for help in passing legislation, it will indicate a change of direction.
A further complication is the legal turmoil likely from the Mueller probe, as well as other investigations likely to be pursued by the Democrats in the House. Despite the president’s firing of Attorney General Jeff Sessions, the investigation will go on and indictments could still be brought. Acting Attorney General Matt Whitaker and his possible successor will have a fine legal line to tread in any efforts to impede the investigation, and face certain questioning from House Democrats with subpoena power. Rep. Jerrold Nadler (D., N.Y.), the incoming chair of the House Judiciary Committee, has said Whitaker will be the first witness his panel will summon in January.
Emoluments could be the word of 2019. (It means, roughly, “profiting from holding office,” and it is proscribed not once, but twice, in the Constitution, prohibiting payments from foreign entities or doing business while holding office without the approval of Congress.) With House Democrats pledged to pursue Trump’s tax returns and probing his business dealings, any White House desire for bipartisan action could fade. Despite the president’s recent words of admiration for the skills of the presumed incoming Speaker of the House Nancy Pelosi, his pragmatic reaching out in a bipartisan manner may be offset by the need to keep her as a convenient face of the enemy to ratchet up his loyalists and incite anger at further investigations.
Impeachment may be talked about among House Democrats, but any action is unlikely, given that the Republican Senate would not support it without convincing evidence produced by investigations and an overwhelming public demand.
History may give us some indication as to the effect this will have on the markets. The Dow during the Nixon administration peaked when the Watergate burglars were indicted and did not begin to recover until after President Nixon’s resignation in 1974. The market did not fully recover until the summer of 1982.
But the parallel is inexact. The current economy is strong. In the 1970s, there were other stronger economic pressures on the market to push it underwater, such as runaway inflation, sky-high interest rates, and the oil crises in 1973 and 1979. There was also a recession from 1972 to 1975, stagnant economic growth, and high unemployment. None of these issues are present now.
Similar to the conundrum facing President Trump, the House Democrats now face a tug-of-war between legislation and investigation. Pelosi is likely to withstand a challenge in her bid to become Speaker, despite a significant number of newly elected Democrats who pledged not to vote for her. Though it may take some time for these new progressive members to coalesce into a force resembling the conservative Freedom Caucus that bedeviled Republican Speakers John Boehner and Paul Ryan, her leadership skills could be tested soon.
As for any future legislative action, the Affordable Care Act—Obamacare–now seems safe from Republican repeal efforts, with the House Democrats unlikely to agree on any move to scrap it. Senate Majority Leader Mitch McConnell has indicated that he has discussed bipartisan fixes with Pelosi. The uncertainty being removed is what begins to make investing in healthcare more attractive; now that it is likely Obamacare can be improved but not terminated.
One area where there are early indications of bipartisan legislative agreement is drug pricing. Trump has said lowering the cost of prescription drugs is a priority and he has indicated a willingness to work with Democrats, as has McConnell. The Creates Act, which would speed approval of cheaper generic drugs by reducing the ability of big pharmaceutical companies to block smaller firms from development, has bipartisan support, though the powerful industry lobby could make passage difficult. Trump has backed Democrats allowing Medicare to negotiate drug prices–effectively rescinding a 2003 Bush administration agreement–but has failed to follow through. If Trump does pursue this, it will put pricing pressure on the pharmaceutical firms and cause drug stock prices to fall and profits to decline. In that event, we would be likely to stay away from this area of investing.
Earlier in his term, the president put forward a plan for $1.5 trillion in new spending on the country’s roads, bridges, airports, waterways, and other crumbling infrastructure. This is one bipartisan issue with economic implications which we believe Congress and the White House could come to terms with. The main issue will be how to pay for it. Road and bridge repairs can be put off for only so long. But the president, who prides himself as a builder, has shown no sign of worrying about the costs of infrastructure renewal and may work with Democrats in order to counterbalance the fiscally conservative Republicans as we head into the pothole-plagued spring. The longer this issue is put off, the more likely a disaster such as a bridge or tunnel collapse could occur, which would cause a public uproar and demand for action.
We believe that consumer confidence will peak in the first or second quarter as the middle class figures out that the recent tax cuts really don’t benefit them as promised. A decrease in consumer spending combined with rising interest rates, an uptick in prices, and tariff increases without an increase in wages will cause consumers to hold their wallets tighter than usual.
Overall, the economy is still strong. The Fed is likely to go on increasing rates as the economy continues to improve, and it is likely those rate increases will irritate Trump. The corporate tax cuts have pushed the stock prices higher as CEOs poured incoming offshore cash into stock buybacks instead of plant reinvestments. Who can blame them when industrial capacity utilization is still low? Why build another plant if you have more capacity to exploit with the existing plant and equipment?
We still like the market based on the continued strength of the overall economy. However, we are proceeding with caution going forward and do not expect investment returns and corporate profits for 2019 to be as strong as the first three quarters of 2018.
Disclaimer:
While this article may concern an area of investing or investment strategy in which we supply advice to clients, this document is not intended to constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services. Any statements regarding market or other financial information is obtained from sources which we and/or our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information.
Past performance should not be taken as an indicator or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. As with any investment strategy or portion thereof, there is potential for profit as well as the possibility of loss. The price, value of and income from investments mentioned in this report (if any) can fall as well as rise. To the extent that any financial projections are contained herein, such projections are dependent on the occurrence of future events, which cannot be predicted or assumed; therefore, the actual results achieved during the projection period, if applicable, may vary materially from the projections.