If you live in the United States, it is hard to escape news of the upcoming midterm elections on 6 November. But for investors, are these midterms really significant?
Importantly, we believe trade policy risk will continue unabated regardless of the outcome. It is true that the stock market usually does well after the midterms, and seems to do particularly well when there is a split government – indicating that investors tend to prefer both gridlock and some check on power.
But will markets react favorably this time if the pundits and prediction markets are correct, and the elections produce a Democratic-controlled House of Representatives (albeit by a narrow margin) and maintain a Republican-controlled Senate? While we see this outcome and resulting gridlock as the base case, we also see a wider range of policy risks, both downside and upside, in the form of “the three I’s”: Infrastructure, Investigations and Impeachment.
Infrastructure: We’re skeptical, but can’t rule out an upside surprise. We have been skeptical about the potential for additional fiscal stimulus in a split Congress in 2019, given the large deficits the U.S. is running, the need for the next Congress to address the so-called fiscal cliff – a big step-down in spending levels if Congress does not act (though we believe it will) – and the fact that while the parties agree about the need for additional investment in infrastructure, there is little agreement about what it should look like and how it should be paid for.
But, but, but: While we are inclined to agree with the naysayers, we see more potential for an upside surprise on infrastructure than the markets are pricing in. The folks we talk to on Capitol Hill emphasize that Democrats want to show they can govern, and since infrastructure was one of the president’s main priorities, they believe a deal can be done. We see only a small window to do so, however: in the beginning of the next session of Congress, before congressional Democrats begin investigations of the Trump administration in earnest. In our view, if we don’t see real traction on infrastructure by late spring, it is unlikely to happen at all.
Investigations: The only “sure thing” in a split government. We’d expect much more oversight of the Trump administration, as items large and small (including the president’s tax returns, the use of private jets by administration officials, etc.) will likely be investigated by various House committees, which all have subpoena authority. While it is unclear whether these investigations would result in findings of real consequence, they could exacerbate what is already an unusually partisan and polarized environment on the Hill – thereby decreasing lawmakers’ ability to work together when and if the economy slows or a broader geopolitical crisis erupts.
Impeachment: Not likely. We believe the risk of impeachment proceedings against the president would be relatively low in a split Congress, assuming that Nancy Pelosi is once again the Speaker of the House. (Remember: Impeachment requires only 50% of the House, while conviction with removal from office requires two-thirds of the Senate.) We would expect Pelosi to avoid impeachment as simply a partisan exercise, understanding that it may diminish Democrats’ chances to take back control of the White House and Congress in 2020. Impeachment risk would increase under a less-experienced speaker who may be less able to fend off various cohorts agitating for impeachment. While impeachment without conviction does not really mean much, it would diminish any remaining comity on the Hill and make it that much more difficult to produce substantive bipartisan legislation.
From an investor’s perspective, the most important takeaway from the midterm elections is that trade policy risk will likely continue unabated no matter the outcome. Trade has created some strange bedfellows: Many Democrats sympathize with the president’s tougher approach, especially as it relates to China, while others worry about alienating labor groups, which generally support the president. Moreover, given the president’s broad unilateral authority over trade, he does not need congressional support to enact policy.
One exception is that the president will need Congress to ratify the “new NAFTA” (the United States-Mexico-Canada Agreement, or USMCA), and a Democratic-controlled House may insist on putting its imprint on it. This could increase the risk that the president at least threatens withdrawal – one more risk that would roil markets.