Last weekend I discussed the fact we had started using the rally to lift some exposure out of portfolios ahead of the mid-term elections simply as a hedge for the “unknown.”
Well, on Tuesday, the ballots were cast and while the Republicans were able to hold onto the Senate, they lost the House. As I wrote on Tuesday, where the markets are concerned, that may not be a bad thing.
“The safest outcome for the markets, and the economy, is what is most likely. The Republicans will likely retain control of Congress but will lose enough seats in the House to make passage of any of the ‘Trump agenda’ unlikely. This will result in Congressional gridlock which will limit any substantive changes over the next couple of years. The markets have historically favored gridlock and would likely be a short-term positive for stocks.”
That was indeed the “sigh of relief” seen by the markets on Wednesday as the bulls created a massive one day advance that pushed the markets above key resistance levels. Unfortunately, it didn’t take long for investors to return their focus back to the things which are going to matter the most – corporate earnings and monetary policy.
As I noted in Thursday’s missive on rising headwinds to the market, earnings expectations have already started to get markedly ratcheted down for the end of 2019.
More importantly, beginning in 2019, the quarterly rate of change in earnings will fall back to the expected rate of real economic growth. (Note: these estimates are as of 11/1/18 from S&P and are still too high relative to expected future growth. Expect estimates to continue to decline which allow for continued high levels of estimate “beat” rates.)
So, really, despite all of the excitement over the outcome of the mid-terms, it will likely mean little going forward. The bigger issue to focus on will be the ongoing impact of rising interest rates on major drivers of debt-driven consumption such as housing and auto sales. Combine that with a late stage economic cycle colliding with a Central Bank bent on removing accommodation and you have a potentially toxic brew for a much weaker outcome than currently expected.
As my friend and mentor Doug Kass recently noted, the election has only served to “poison” the political pot even further.
“The ugliness of the political scene over the last two years is likely to get more ugly. Though Trump will likely be emboldened – there is now a fundamental difference and divide from the recent past (“checks and balances”). The President no longer has a subservient (Republican) House to deal with anymore – the new (Democratic) House is in marked opposition to his agenda. The President will continue to argue that he is at the epicenter of power – but he no longer is.
As we move towards 2020, the U.S. political scene is headed for a period of elevated animus (even more than we have seen in the past few months) between the Democratic and Republican parties. Whether it’s the affirmation/restoration of voting rights, gerrymandering, infrastructure, the border wall (and other immigration moves), healthcare, etc. – rhetoric will grow even more heated.
In the lame duck session, there will be plenty of fighting over the border wall and other Trump initiatives – it will get messy.
I suspect little, administratively, will be achieved over the next 12-18 months.”
He is most likely correct. It is likely little will get done as the desire to engage in conflict and positioning between parties will obliterate any chance for potential bipartisan agenda items such as infrastructure spending.
Furthermore, there is more than a significant risk to the financial sector with the Democrats now in control of the house. The financial services committee has the support of Democratic members of both the House and the Senate to launch new regulations aimed at increasing oversight on major banks. Given the amount of leverage currently being used to support the financial markets – this could pose a real threat to both the sector, the economy, and the overall markets.
Note: we sold our financial holdings last week. With portfolios reduced to 50% equity, we have a bit of breathing room currently to watch for what the market does next.
Daily View
Despite the decline of the market during October, investors really never showed much in terms of “fear.” Volatility never spiked much above the long-term average of 20, interest rates didn’t decline much, and investor’s quickly got back their bullish attitudes.
