The results of the U.S. midterm elections fell in line with expectations, with Democrats winning control of the House of Representatives and Republicans maintaining control of the Senate. That should spell good news for U.S. markets, although some potential risks also lie ahead, according to BMO market professionals.
“From an equity perspective, this could be a best-case scenario in terms of less rhetoric from both sides,” said Brian Belski, BMO Capital Markets Chief Investment Strategist. “Also, stocks run on fundamentals. Earnings growth has stabilized dramatically, and we believe U.S. equities are poised for a very strong recovery heading into 2019.”
The U.S. economy similarly has exhibited strong momentum. Mike Stritch, Chief Investment Officer of BMO Wealth Management U.S., noted that the midterm results are likely to have a limited impact on that trajectory.
“There are three material ways Congress can impact a $20 trillion economy: tax policy, fiscal spending and regulatory changes,” Stritch said. “All three of those levers have previously been pulled and are now tailwinds to economic growth. We are comfortable with our moderate-overweight position on risk assets, with a particularly favorable view on U.S. equities.”
Equity and Currency Markets
Stritch noted that from a historical perspective, U.S. equity markets are poised for a strong run. “Going back to 1946, the S&P 500 has risen in every 12-month period following the midterms,”1 he said. Stritch added that valuations are reasonable, while fiscal stimulus should remain a tailwind in 2019. And while October was a rough month for equity markets, the underlying fundamentals remain strong, indicating that the recent pullback is likely a temporary setback.
“Although interest rates are trending up, real rates—the difference between nominal interest rates and inflation—are still close to zero,” Stritch said. “Periods of protracted stock declines also tend to correspond with periods of earnings contractions and overall recessions. While earnings growth may have slowed in the third quarter, we’re still forecasting 7- to 10-percent growth for fiscal 2019, which is a very good number by historical standards.”
The October jobs report signaled that employment growth is solid while wages grew 3.1 percent year over year,2 which should be favorable for consumer spending while inflation remains contained. But Jon Adams, Portfolio Manager at BMO Global Asset Management, warns that higher payrolls introduce potential risks.
“The Fed has indicated that they may need to raise rates above what they consider a neutral rate,” Adams said. “A hike in December and two more next year would get them close to what they consider a neutral level. If they need to raise rates three or even four times next year, that could potentially weigh on equities.”
On the currency side, the U.S. dollar was lower across the board in the wake of the elections. But Greg Anderson, BMO Capital Markets Global Head of Foreign Exchange Strategy, believes the strong economy and ongoing trade skirmishes—particularly with China—should be positive for the U.S. dollar on a three-to six-month horizon. “Trump has pursued this policy and it hasn’t cost him much politically,” he said. “For many politicians, losing the House would make them more cautious in their dealings with China in the way that Presidents Obama and George W. Bush were cautious. But Trump is not so risk averse, so this election is unlikely to change his approach.”