The results of the US midterm elections were largely in line with expectations, with one important wrinkle. Although, as anticipated, the Democrats took the House of Representatives and the Republicans held the Senate, the Republicans increased their majority in the Senate and this, from a political perspective, appears to validate the President’s strategy of taking a hard line on immigration and trade.
This mixed result should increase the odds of a slower US economy in 2019 and beyond, with potentially dampening effects on bond yields and the dollar and, possibly, US stocks. However, the impact of the election results on US trade policy is still uncertain and this will have a major bearing on the performance of global equities. To see this, it is first important to recognize that the 2020 election campaign is now underway and then look at how political considerations may impact five different issues:
Taxes: On taxes, the midterm result likely kills the idea of “Tax Reform 2.0”. A tax bill can’t pass without a majority in the House of Representatives and the Democrats will have zero interest in passing another big tax cut that the President would take credit for and could heat up the economy in time for the 2020 election. The easiest strategy for the Democrats would be to endorse a middle-class tax cut but only one that is funded by higher taxes on upper income individuals and/or corporations. This would, in turn, be unacceptable to the Senate.
Infrastructure: Democrats might be willing to support more money for infrastructure if it included improvements to the electrical and internet grids. However, a lack of money and a lack of available construction workers suggests that a moderate rather than large infrastructure bill is the most that could occur.
Health Care: With the individual mandate disappearing in 2019 and more states trying to adopt coverage-lite plans, the Affordable Care Act will likely become less effective over time. Democrats will have no interest in repealing and replacing it. Republicans may be willing to provide extra funding to support the exchanges, as exit polls suggest that health care is the Democrats’ most potent issue going into 2020. However, because it is, it is unlikely that House Democrats would agree to any bill that would be supported by a Republican Senate. Bipartisan support could, however, be found to combat opioid addiction and to limit drug price increases.
Immigration: The Democrats’ victory in the House dooms funding for the President’s border wall. However, in other respects, the President has wide latitude in enforcing immigration policy. He will likely perceive that his hard line on immigration worked in turning out the Republican base on election day and so he is likely to maintain this hard line over the next two years. However, this would exacerbate a current worker shortage and could contribute to somewhat slower economic growth in 2019 and 2020 than a more immigrant-friendly policy.
Trade: In a similar vein, Congress over the years has ceded a great deal of authority on trade to the Executive. Because of this, the President will be free to pursue a more aggressive strategy on trade with China, if he wants to do so.
The crucial question is whether he will want to make a deal with Xi Jinping or not. While continuing tough rhetoric on trade would not directly hurt the President politically, it would damage both the global economy and U.S. economy, which could leave him more vulnerable in 2020. He may also calculate that, in making a deal with China, he could claim that he got a better result than any other US President could have, and he would still have plenty of targets to blame, if something goes wrong in the economy, in House Democrats, illegal immigrants and, increasingly the Federal Reserve.
This trade issue is clearly the wild card for both the global economy and investing. If 2019 brings with it a major escalation in the trade conflict with China, with no resolution in sight, it would be a significant negative for global and US stocks and could lead to a higher dollar and lower interest rates.
If, however, the President cuts a deal with China, then the investment environment should be one of slowing US growth relative to the rest of the world, due both to a lack of further stimulus and a shortage of workers. In this environment, stocks outside of the US could well regain the advantage that they had in 2017 but then lost this year as the US economy experienced a strong, but temporary surge in growth.