Investment Outlook December 2018

Global equities should benefit from the US mid-term elections

In the US November mid-term elections, the Democrats regained control of the House of Representatives (House), but failed to win a majority in the Senate. Arguably, this may be the best possible outcome for equities, as the risk of the Democrats winning the Senate and repealing tax cuts was removed. Moreover, the chance of the Trump administration pushing for more tax cuts through a Republican controlled Congress, which could potentially lead to an overheating economy and higher interest rates, has been lowered somewhat. Nevertheless, it should be possible to get bipartisan support in Congress for greater infrastructure spending to potentially lift US productivity growth.

Going forward, we expect long-term Treasury yields to remain range bound and for the US dollar to weaken in anticipation of the Fed not hiking rates by more than the market expects. The key beneficiaries could be those markets (e.g. emerging markets, and particularly those in Asia) that have been adversely affected by dollar appreciation this year, and are priced at fairly undemanding valuations. US stocks may also gain; the S&P 500 stock market index has been higher one year after every midterm election since 1946.

Looking at the midterms with a view to the 2020 presidential election, the results were somewhat mixed. The Republicans won the governorships of Florida and Ohio; both these states were crucial for Trump’s win in 2016. If the Democrats were to send a president to the White House, they will likely need to take these swing states. On the other hand, the Republicans lost the governorships in Wisconsin, Michigan and Pennsylvania. It was not lost on some voters (e.g. soybean farmers in Wisconsin) that China had been deliberately targeting certain sectors by raising trade tariffs on imported US agricultural products. The cost of raising US import tariffs on raw materials, like steel, has also had a detrimental impact on auto manufacturing. For instance, General Motors’ recent decision to shut two plants in Michigan is unlikely to be well received by traditional blue-collar Trump supporters there. The disappointing results in these Midwestern states may encourage Trump to ratchet down the US trade spat with China. Undoubtedly, the state of the economy in November 2020 and the Democrats’ presidential candidate choice are likely to determine who wins the keys to the White House.

A market focus is what the mid-term election means for President Trump. Given that the Democrats now have control of the House, they will also chair House committees that can dictate the hearing schedules or launch investigations into the Trump administration. For instance, the important House Ways and Means Committee has the power to examine the president’s tax filings, which Trump steadfastly refuses to release, without his permission. That could provide material for an array of investigations into Trump’s finances and political connections, that could become a drag on US and global equities.

The UK-EU divorce deal has increased risks for UK financial assets

Finally, after two years of negotiations, the UK government finally agreed a Withdrawal Agreement (WA) text with the EU. The deal includes the contentious “backstop” arrangement over the Irish border issue that cannot be ended without the EU’s consent. The PM now faces a battle to get the deal through parliament in December. She appears to have lost the support of the Democratic Unionist Party, which provides a majority in the House of Commons (HoC) for the government, and Eurosceptic Tories. Moreover, there is also a growing chorus of Tories demanding a confidence vote in her leadership. The possibility of the UK leaving the EU without a deal will actually increase if the PM fails to get the WA through the HoC. Looking forward, the political consequences of Brexit (and the potential of a left-wing Jeremy Corbyn government should a snap election be called) are likely to remain a drag on the performance of sterling-denominated financial assets.

Falling crude energy prices do not necessarily imply a slump in global growth

Brent crude oil prices are down 28% from a peak of $86/b at the start of October. Much of the reason for this decline can be traced back to speculators reducing risk following the recent equity sell-off by cutting their positons in crude oil future contracts on commodity exchanges. The energy market is also concerned with over-supply after the US appeared to have watered down its sanctions on Iranian crude oil exports by introducing waivers for its major customers. However, the crude oil demand side of the equation appears relatively healthy, backed up by global growth of around 3% forecast by the IMF for next year. Although the US is tightening monetary policy, the real Fed funds rate is around zero and unlikely to be a drag on the economy. Moreover, US and Chinese fiscal policy is accommodative for growth. In short, the decline in the crude oil price largely reflects an oversupply, rather than concerns about global growth, which could unsettle equity markets.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Please remember investment involves risk. The value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.