In today’s mid-term elections, Democrats are likely to capture the House of Representatives, while the Republicans will maintain their Senate majority. While this potential combination of a Republican President and a split Congress may seem like gridlock, stock markets have historically fared well. It tends to constrain political overreach, resulting in a stable backdrop for markets.
Over the past two years, tax cuts have been enacted and the much-maligned Affordable Care Act (“Obamacare”) survived repeal and has been embraced by more Americans. With these two major initiatives settled, voters seem content to rebalance power and impose more checks on the executive branch.
What It Means For Markets
A split congress would be broadly bullish for equities, as it supports the status quo.
The long term growth outlook should remain unchanged. The Republican ambitions to make individual tax cuts permanent would be unlikely to materialize. While these tax cuts may have boosted short-term growth, they would have also raised the risk of overheating the economy, resulting in more aggressive U.S. Federal Reserve (“Fed”) rate hikes. And extending the tax cuts would have further amplified the debt burden, eventually weighing on borrowing costs.
Ending Republican Congressional control will likely result in a marginally weaker dollar. However, a pullback in the currency should keep U.S. exports more competitive and generally be supportive of Standard & Poor’s (“S&P”) 500 earnings.
What Business Impact Could The New Congress Have?
A Democratic-led House may push for increasing the minimum wage, controlling drug prices and launching infrastructure spending. All three policies should be met with some support, particularly from President Trump as he looks to champion main-street issues ahead of the 2020 Presidential election.
Minimum wages have become a significant issue. Amazon recently announced an increase in its minimum wage to $15 an hour and encouraged others to follow suit. This was partly in response to criticism of its business practices from the White House and former Presidential candidate Bernie Sanders. Amazon also promised to lobby for increasing the decade-old federal minimum wage from $7.25. Even if Congress doesn’t support an increase, high-profile political pressure and the tightest job market in almost 50 years seems to be having an effect.
Broad-based minimum wage increases would be felt most in the service economy, particularly in labor intensive sectors such as consumer discretionary and consumer staples. That could certainly pinch profitability, but it depends on a company’s ability to pass costs through to consumers.
Healthcare costs and drug pricing are likely to be scrutinized by a Democrat-led House. Escalating drug prices have also drawn criticism from the President, so there is some bipartisan support to contain increases. Across specific sectors, biotech and pharmaceutical are the most vulnerable to potential drug price controls. However, serious disruption in healthcare is unlikely as each party will constrain the other in attempting to dial back or increase existing services.
Infrastructure spending has appeal across both parties. The challenge has always been on how to best select and qualify “shovel ready projects.” Proposed solutions tend to run into conflicts as each party has different priorities on what regions and projects should be targeted. As in previous attempts, it still looks like a low probability to get a large program up and running. There may be opportunity for some small, targeted projects. Industrial and materials sectors could benefit from any uptick in spending.
President Trump To Focus On Geopolitics
As President Trump plans his 2020 re-election campaign, a potential gridlocked Congress is unlikely to deliver any notable wins to help expand on his domestic or economic agenda. Therefore, Trump will likely focus on his broad executive powers to impact trade and national security.
The obvious opponents are China and Iran. The issue with China is unfair trade and pilfering U.S. technology, while the contention with Iran is that it has cheated on its nuclear program.
While both issues demand detailed strategic solutions, Trump’s transactional style so far has been to ramp up pressure ahead of negotiations through confrontational Tweets. This helps to establish a threatening stance that inspires his base and fires up the news coverage. Given those political benefits in an election cycle, Trump has little incentive to settle quickly on either issue unless there is a growth scare. His pressure tactics will likely raise geopolitical risk and asset volatility well into next year.
Late last week, Trump announced that in a telephone conversation with Chinese President Xi Jinping, they discussed trade and were “moving along nicely.” Market reaction was mixed with some analysts optimistic, while others viewed it as a ploy to stoke equity markets ahead of the mid-terms. In follow up comments, Larry Kudlow, White House economic advisor, downplayed the progress. It seems like negotiations are still at the early stages of getting restarted.
Regardless of a potential Democratic majority in the House, President Trump remains an unpredictable factor for investors. Growth and markets could ultimately suffer if tension ramps up with China and Iran. Geopolitical missteps could bring about the next recession sooner than expected.
This article originally appeared on Forbes