With the midterm elections now behind us, I am pleased to share this analysis and update from Cetera Investment Management.
Red and Blue Waves Turn to Purple Haze
• Investors anticipated the election outcome correctly and stocks are rallying as uncertainty
(risk) is being reduced from markets.
• Now Democrats have the majority in the House of Representatives, while Republicans
have the majority in the Senate. However, stocks have historically done well in gridlock.
• Regardless of the election results, U.S. growth was expected to slow in the coming years.
Gridlock will not change this and investors should diversify risks accordingly.
After months of political advertisements, testimonials, fliers and pollster phone calls, the 2018-
midterm elections are finally over for Americans. It has been a contentious election season and
many are glad it is over. Unfortunately, political rhetoric is likely to remain heated. As expected,
Democrats gained the majority in the House of Representatives and the Republicans increased
their majority in the Senate. Early investor reaction was positive and equity markets are climbing
as the expected outcome came to fruition. Markets do not like uncertainty, which is risk.
While the initial market reaction is comforting to investors, the next question is what does this
mean for the future? Gridlock, which has historically ensued from a split Congress, has been good
for stocks. Some would view this as positive, because gridlock prevents Congress from enacting
policies that may hamper growth. This time may be different from that perspective, as the current
administration’s more pro-growth policies are likely on hold now. Permanent tax cuts for individuals,
deregulation, and healthcare reforms are likely not going to move forward. The good news is that
while we may not move forward with policies that will help growth, we are not going to go
backwards either. The policies already in place, like permanent tax cuts for corporations, are
unlikely to be reversed. Also, sectors that Trump had targeted like technology and health care may
benefit from the election results.
Potentially hampering growth, President Trump still has authority as it relates to foreign policy such
as tariffs and trade deals. Also, any additional spending will be difficult to get approved. This is
why U.S. Treasury bonds are also rallying. Infrastructure spending would also be difficult to
implement now, but we were skeptical on that as the budget was already tight and this topic
seems to only come up before or right after an election and then fades away.
Whatever the outcome, the economy was expected to slow in coming years. Growth in corporate
earnings has been very high and expected to come back down. The ISM Manufacturing and Non-Manufacturing
PMI’s are both at elevated levels, while consumer confidence is at an 18-year high
and the unemployment rate sits at a 49-year low. With this backdrop, the Fed has been less
accommodative and expected to hike rates once more this year and two or three times next year.
However, a Democrat controlled House may hamper fiscal stimulus, which may in turn cause the
Fed to slow down on rate hikes. We are nearly 10 years into an economic expansion and growth will naturally slow as all economic cycles end eventually. Growth around the rest of the world is already slowing.
While the split Congress will likely cause gridlock, policies already enacted will remain. With the
budget deficit where it is (expected to reach 4% of GDP according to the bi-partisan Congressional
Budget Office), Congress was unlikely able to spend more money anyway. We continue to focus on
economic fundamentals and diversify risks in the market. Credit spreads are tight in bonds and
interest rates are expected to go higher. In equities, valuations have come down, but corporate
earnings growth will likely slow. Volatility will continue to be elevated, so we urge investors to
maintain broad diversification among asset classes.
This report is created by Cetera Investment Management LLC
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