midterm elections

By Melanie Waddell, ThinkAdvisor

The midterm elections, as predicted, flipped the House to the Democrats and left the Senate under Republican control. Political pundits and industry officials are now prognosticating what it all means for the markets and investments as well as for hot-button issues like taxes, health care and regulation.

John Lynch, chief investment strategist for LPL Financial, stated that it’s a “’something for everyone’ election, as both sides are seemingly pleased with the results.”

While the results were as anticipated — with the Democrats gaining 35 seats in the House — the Republicans “increased their majority in the Senate and this, from a political perspective, appears to validate [President Trump’s] strategy of taking a hard line on immigration and trade,” noted David Kelly, chief global strategist for J.P. Morgan Asset Management, in his Wednesday morning commentary.

For starters, Kelly said, the midterms’ “mixed result should increase the odds of a slower U.S. economy in 2019 and beyond, with potentially dampening effects on bond yields and the dollar and, possibly, U.S. stocks.”

However, the impact of the election results on U.S. trade policy “are still uncertain and this will have a major bearing on both the absolute and relative performance of U.S. and international equities,” Kelly opined.

Lynch adds that congressional gridlock may “perhaps” be good.

“S&P 500 Index futures are up solidly overnight,” Lynch said. “Moving past the uncertainty is positive. The market got what it expected, which — all else equal — is positive. Some investors like checks and balances that can take extremes out of play. The S&P 500 is now in the 12-month period post-midterms, and the S&P 500 has not been down in this period since 1946.”

Based on history, Lynch continued, “Republican presidents and a split Congress have been one of the best combinations for stocks, which have gained 15.7% on average in this scenario based on the S&P 500.”

Election results aside, LPL believes “the key market drivers will remain the same,” Lynch states.

Trade and the Federal Reserve, he said, “will still be primary considerations for investors” despite the midterm outcome.

LPL’s “focus will remain on the solid fundamentals supporting economic growth, the direction of interest rates, and the impact of record corporate profits on the financial markets.”

Post the midterms, here’s how Kelly and Lynch see the following issues shaping up:

Taxes

The House flip “likely kills the idea of ‘Tax Reform 2.0,’” Kelly states.

A tax bill can’t pass without a majority in the House, “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,” Kelly adds.

The easiest strategy for the Democrats: “to endorse a middle-class tax cut but only one that is funded by higher taxes on upper-income individuals and/or corporations,” Kelly said. “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,” Kelly opines. “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.”

Added Lynch: “A small infrastructure bill is a possible area of compromise” between Trump and House Democrats.

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,” Kelly said.

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,” according to Kelly.

Added Lynch: Medicaid expansion “may be in the cards under more Democratic leadership, while efforts to control drug prices are likely to continue.”

Immigration

The Democrats’ victory in the House “dooms funding for the president’s border wall,” Kelly said. “However, in other respects, the president has wide latitude in enforcing immigration policy.”

Trade

In a similar vein, “Congress over the years has ceded a great deal of authority on trade” to the president, Kelly said. “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: whether Trump will want to make a deal with President 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,” Kelly said.

Regulation

Deregulation efforts by Republicans “may slow down, though executive orders remain in play,” Lynch said.

The House Financial Services Committee — under new chairwoman Rep. Maxine Waters, D-Calif., “will not be nearly as friendly to the financial services industry,” Lynch said. “The committee’s efforts may slow the pace of the president’s deregulation efforts.”

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