Legislative gridlock in the US?

Capital International Group
November 15, 2018

No More ‘Easy’ Political Wins

There was a collective sigh of relief from beleaguered pollsters after mid-term election results in the US aligned with consensus forecasts: democrats won control of the House of Representatives and republicans maintained control of the Senate. Only the degree to which the senate shifted further to the republicans caused mild surprise. President Trump was quick to claim victory and the democrats’ hoped-for ‘blue wave’ failed to materialise. However, losing the house is likely to stymie policymaking going forward, with the newly empowered democrats keen to restrain the president going forward. The democrats will now have to content themselves with using the House as a platform for outlining the party’s priorities on a range of issues with a view to the 2020 elections.

So what are the market-ramifications of a divided congress for the remainder of President Trump’s term? The market rally following the result was a strong indication that investors feared a democrat clean sweep and the risk of rollbacks to key pieces of legislation – tax reform for example – have reduced significantly. Most neutrals would probably conclude that a split congress restores congressional checks and balances on the Trump administration.  Moreover, the long-term growth outlook for the US economy should remain unchanged.

Stock Market Performance Post Elections

According to research by LPL Financial, a Republican president with a split congress is the third best combination for subsequent returns for the S&P 500 with an average annual performance of 15.7% (see chart below).

Without drawing too many far-reaching conclusions from this, it does indicate that a split congress is no particular impediment to future stock market returns.

Healthcare Reform

Set to be a major issue over the next few years. Democrats had significant success campaigning for drug pricing legislation and the preservation of the Affordable Care Act (also known as ‘Obamacare’), with healthcare featuring high on the priorities list of voters. Whilst President Trump has been publicly supportive of changes to drug pricing, some resistance from the senate is expected. Republicans will have to tread carefully though for fear of appearing obstructive to democrat proposals on this sensitive issue. A repeal of Obamacare appears to be off the agenda, possibly for good. Moreover, without a coherent health-care plan of their own, Republicans will continue to be vulnerable on this issue.

Infrastructure Spending

This is one area where both parties could find compromise. A larger infrastructure-spending programme was a topic both parties agreed on during the presidential election and a bipartisan focus could bring about a sustainable domestic infrastructure investment plan. The caveat to this scenario would be a reluctance from the democrats to support something that spurs the economy and boosts the Republicans’ chances of winning the next election. Furthermore, whilst both parties have supported infrastructure spending, the details differ substantially.

Changes to Foreign Policy?

With a gridlocked congress unlikely to deliver any significant wins domestically, President Trump’s focus may turn more towards trade and national security. There is widespread belief in Washington that China has engaged in unfair trade practises and state-supported enterprise for example. Therefore, there is unlikely to be a significant de-escalation of trade tensions due to the new political landscape. In addition, the Democrats are likely to propose a tougher policy towards countries with poor human rights records such as Saudi Arabia and North Korea. There will also likely be plans for Russia-related investigations, such as potential Russian interference in elections and conflicts of interest between President Trump’s inner circle and Russian officials.

Winners & Losers?

Markets tend to look through short-term political ‘noise’; however, there was some reaction from stocks once a clear outcome emerged. In the immediate aftermath, the perceived winners were industrial and materials stocks on speculation of a possible infrastructure deal, especially companies with exposure to public work projects. The perceived losers were large pharmaceutical companies on the prospect of a future clampdown on drug pricing (although the outcome could have been worse with a Democratic clean sweep). However, the result was a good one for hospital stocks and healthcare insurers with the threat of repeal to Obamacare diminished.

Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.

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