Some of the President’s Men: Investment implications for US mid-term elections

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Some of the President’s Men: Investment implications for US mid-term elections

Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

Stéphane Monier

Chief Investment Officer
Lombard Odier Private Bank

Last week’s conviction of two former aides to President Donald Trump make it more urgent to look at the US mid-term Congressional elections, scheduled for 6 November. We see three possible scenarios and look at the investment implications for each.

Traditionally the US mid-term elections provide a referendum on the incumbent president. The Republican Party holds majorities in both the Senate and House of Representatives and eleven weeks from now voters will decide 35 of the Senate’s 100 seats and all 435 seats in the House.

Last week may prove a milestone in the Trump presidency. For the first time a court linked Trump to convictions for tax fraud and breaking campaign finance laws by his personal lawyer and his then campaign manager. Seven of Trump’s former aides and advisers have now pleaded guilty or been found guilty of crimes linked to his campaign in an investigation looking for links to Russian officials1.

In this context the US mid-term elections, which come around every four years, may hand the Democrat Party control of the House of Representatives, changing the political balance of power and the outlook for US markets. That matters because, assuming the current legally incriminating revelations continue, the Democrats look increasingly likely to push to impeach the president.

Below are the three scenarios we see, with their respective probabilities, based on current polls and models2:

  1. A divided Congress is our base scenario. Using consensus results from polls and models, we expect the Democrats to win a majority in the House and the Republicans to retain control of the Senate (55% likelihood)
  2. Unchanged – Senate and House remain majority controlled by the Republicans (35%)
  3. Democratic sweep – with both houses of Congress switching control (10%).

Also, an unusual number of Republicans in vulnerable seats have resigned, retired or stepped down over the last two years, adding to the chances that the Democrats will win seats in November3.


Honour and division

Before we turn to the investment implications of each scenario, we should remember that impeachment of an American president is a political, not a legal process. The writers of the 18th century US constitution assumed that a president facing prosecution would resign as a matter of honour. That was a valid assumption until this US administration. In 1974, Richard Nixon resigned when he had lost support from his own party and before any charges were brought and in 1999 the Senate acquitted Bill Clinton who served out his second full term as President of the US.

Still, in our base scenario of a divided Congress, any Democrat attempt to impeach Trump through a simple majority in the House of Representatives is destined to fail in a Republican-controlled Senate. A two-thirds majority in the Senate backing an impeachment process is unlikely, unless Republicans suddenly see Trump as a political liability for 2020. The only case where impeachment seems somewhat more likely, with Republicans possibly pushed into abandoning Trump, is a Democrat sweep of both House and Senate. But independent of all this, Donald Trump’s approval ratings have remained stable at around 38% to 43% this year, and even the most recent scandals have shown little sign of impacting his supporters.


Following the money

Let’s now look at the investment implications for each of these scenarios. In the event that our expectation for a divided Congress plays out, we would expect to see a much less efficient US administration, with more reliance on executive authority to achieve what would be blocked through legislation, similar to Barack Obama’s second term in office. In such a setting, fiscal policy would fuel future economic performance to a lesser degree, and monetary policy would take the lead instead, with rising interest rates and a stronger USD. As tax cuts remain in place and corporate profitability continues to progress in line with market expectations, there would be no new fundamental catalysts to boost equity market performance.

An unchanged Congress with Republicans holding onto their double majority would be the most market-positive outcome in the short run. Infrastructure spending would probably continue with possible additional tax cuts. Large spending programmes would also support the dollar. Still, in the longer term, continued levels of high spending would have serious implications for the fundamental solvency of the US economy. As well as being less than welcomed by investors.

Of course, if the Republicans were to win both Congressional houses in this scenario, it would be logical to look to the 2020 presidential election and the possibility that Trump would seek, and win, a second term. In the near-term, that may have consequences for the relationship between the White House and Federal Reserve’s independence, unless the central bank manages to be seen to resist all of Trump’s attempts to sway its interest-rate setting decisions. After Trump’s criticism last week of Fed interest rate normalisation, any perception of continued interference would have profound implications for the haven status of the dollar.

The most immediately volatile outcome would be a Democratic sweep. Wins by the Democrats of both the Senate and House would be the most negative outcome for financial markets in the short term. Firstly, because investors would assume the tax cuts and regulations that have helped to boost markets over the last two years wouldn’t be renewed. Secondly, it would undermine Trump’s pro-business policies. Finally, Trump may also back Democrat legislation on pharmaceutical price controls and raising the minimum wage. Nevertheless, it wouldn’t change the Fed’s policy of raising rates and withdrawing fiscal stimulus. 


Whatever the outcome

Beyond the political noise, the gradually tightening financial conditions are making earnings growth and corporate balance sheets more vulnerable to external shocks, suggesting that investors should look for opportunities to reduce their overall portfolio risk.

After two increases so far this year, we expect the Fed to make another two rate hikes this year and at once or twice more in the first half of 2019. Federal Reserve Chairman Jerome Powell said 24 August that he expects to continue “the current path of gradually raising interest rates.”4 Given that the US economy is still showing “strong performance,” Powell said that he saw no reason to alter the central bank’s policy of gradual normalisation.

For now, Trump’s view of his own central importance to the US economy remains undiminished.

“I don’t know how you can impeach somebody who’s done a great job,” Trump said in a Fox News interview on 23 August. “I’ll tell you what, if I ever got impeached I think the market would crash. I think everybody would be very poor, because,” he said pointing to his own head, “without this thinking, you would see, you would see numbers that you wouldn’t believe, in reverse.”5 

If nothing else, Trump has a strong record in surprising the political class, and as long as his supporters continue to shrug off scandal, he is soon likely to be wrestling his policies through a split US legislature.


Key takeaways

  • US mid-term elections may shake up the legislative balance of power
  • Recent scandals have heightened the stakes for the Trump presidency
  • The outlook for equity markets appears more attractive from a risk/return point of view as we anticipate that the asset class would significantly outperform fixed income assets.


1 https://www.nytimes.com/interactive/2018/08/21/us/mueller-trump-charges.html?action=click&module=Top%20Stories&pgtype=Homepage
2 See https://projects.fivethirtyeight.com/2018-midterm-election-forecast/house/, http://www.thecrosstab.com/2018-midterms-forecast/, http://www.thecrosstab.com/2018-midterms-forecast/
3 https://edition.cnn.com/2017/11/10/politics/house-retirement-tracker/index.html
4 https://www.bloomberg.com/news/articles/2018-08-24/powell-says-gradual-hikes-likely-needed-if-economy-stays-healthy
5 http://www.foxnews.com/politics/2018/08/23/trump-declares-market-would-crash-if-democrats-impeached-him.html

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