Quick Takes On The Midterms

Key Takeaways

  • The U.S. midterm elections resulted in a consensus outcome that was largely expected in prediction markets.
  • Nevertheless, much remains unclear in terms of potential policy shifts and their economic and market implications.
  • The months ahead are likely to test the ability of the U.S. economy to generate and sustain growth in the face of receding stimulus from policy makers.
3 min

Tuesday’s elections brought neither a blue wave nor a red wave. As of early Wednesday, Republicans fortified their control of the Senate by a net gain of 2 seats, while Democrats had a net gain of 28 seats in the House of Representatives. This outcome itself was the modal or consensus outcome which, unlike the presidential election of 2016, betting markets correctly predicted. Hence, overnight reactions in various futures markets were not as dramatic as those from the 2016 election. Major equity markets were only modestly higher overnight by approximately +0.5% to +1% (< 1z) while in 2016 the same markets moved lower overnight by about -5% to -7% (roughly >4z event).

However, much remains unclear in terms of potential policy shifts and their implications for the economy and markets. Looking ahead, what are some of the issues that investors should consider?  

Prior to the elections, my view was that the outcome of the midterms was unlikely to have a material impact on the economic cycle in the U.S. The Republican-led Senate and House have already passed a record tax-cut bill in 2017 under conditions of low unemployment. In the face of the resulting soaring deficits, it is not clear how much further fiscal stimulus is either possible or desirable. The administration has also largely pursued business-friendly policies, through nominees focused on deregulating finance, manufacturing, and mining. This represents an unwind of regulatory policies that had been tight since the global financial crisis of 2008. However, on the monetary front, the Fed has, thus far, independently pursued tightening in anticipation of higher inflation; although, this independence has recently come under pressure albeit of the rhetorical kind.

With split control, investors can expect that the House and Senate will have different near-term focuses. Headline risks, such as increased oversight in the form of an anti-corruption act or impeachment (although not conviction), increase with a Democrat-led House. This may also lead to “gridlock” on the policy front. However, there also appear to be areas in which the two parties can find common ground on select topics, such as prescription drug pricing reform or other aspects of healthcare, which is also widely recognized to have been an important issue to the electorate across party lines.

As well, policies pursued through executive actions, also likely unaffected by the outcome in the midterms, continue to have an impact on investor expectations. The threat of tariffs and an escalation in trade wars have contributed to a selloff in emerging market equities and raised larger questions about longer-term global trade balances. It is not clear that a split control between the House and Senate either ameliorates or exacerbates these concerns. While the House could pass legislation to limit executive actions, there is considerable uncertainty around the timeliness or broad support, even in the House, for such a response.  

Let’s consider election implications for asset markets in terms of three horizons. Given the consensus-expected outcome, the immediate reaction is likely a returning focus on fundamentals and the economy with a continuation of the prevailing short-term sentiment. Over the medium term between now and when the new congress takes office in 2019, investors are likely to learn more details and attempt to further price associated risks. My expectation is that information will be imprecise and incomplete, leading to speculation that may drive volatility and under/overreaction to headlines. That may create opportunities. Over the longer horizon, once the dust settles and the new congress assumes office in 2019, the same challenges from yesterday remain – sustaining economic growth in the face of tightening monetary policy with limits on new fiscal stimulus, increased resistance to deregulation, and broadly slower policy responses. Essentially, this amounts to a real test for the robustness of the U.S. economic expansion and whether it can finally carry the baton of growth absent direct stimulus from D.C.

Legal Disclaimer

These materials provided herein may contain material, non-public information within the meaning of the United States Federal Securities Laws with respect to Acadian Asset Management LLC, BrightSphere Investment Group Inc. and/or their respective subsidiaries and affiliated entities.  The recipient of these materials agrees that it will not use any confidential information that may be contained herein to execute or recommend transactions in securities.  The recipient further acknowledges that it is aware that United States Federal and State securities laws prohibit any person or entity who has material, non-public information about a publicly-traded company from purchasing or selling securities of such company, or from communicating such information to any other person or entity under circumstances in which it is reasonably foreseeable that such person or entity is likely to sell or purchase such securities.

Acadian provides this material as a general overview of the firm, our processes and our investment capabilities. It has been provided for informational purposes only. It does not constitute or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or to purchase, shares, units or other interests in investments that may be referred to herein and must not be construed as investment or financial product advice. Acadian has not considered any reader's financial situation, objective or needs in providing the relevant information.

The value of investments may fall as well as rise and you may not get back your original investment. Past performance is not necessarily a guide to future performance or returns. Acadian has taken all reasonable care to ensure that the information contained in this material is accurate at the time of its distribution, no representation or warranty, express or implied, is made as to the accuracy, reliability or completeness of such information.

This material contains privileged and confidential information and is intended only for the recipient/s. Any distribution, reproduction or other use of this presentation by recipients is strictly prohibited. If you are not the intended recipient and this presentation has been sent or passed on to you in error, please contact us immediately. Confidentiality and privilege are not lost by this presentation having been sent or passed on to you in error.

Acadian’s quantitative investment process is supported by extensive proprietary computer code. Acadian’s researchers, software developers, and IT teams follow a structured design, development, testing, change control, and review processes during the development of its systems and the implementation within our investment process. These controls and their effectiveness are subject to regular internal reviews, at least annual independent review by our SOC1 auditor. However, despite these extensive controls it is possible that errors may occur in coding and within the investment process, as is the case with any complex software or data-driven model, and no guarantee or warranty can be provided that any quantitative investment model is completely free of errors. Any such errors could have a negative impact on investment results. We have in place control systems and processes which are intended to identify in a timely manner any such errors which would have a material impact on the investment process.

Acadian Asset Management LLC has wholly owned affiliates located in London, Singapore, Sydney, and Tokyo. Pursuant to the terms of service level agreements with each affiliate, employees of Acadian Asset Management LLC may provide certain services on behalf of each affiliate and employees of each affiliate may provide certain administrative services, including marketing and client service, on behalf of Acadian Asset Management LLC.

Acadian Asset Management LLC is registered as an investment adviser with the U.S. Securities and Exchange Commission. Registration of an investment adviser does not imply any level of skill or training.

Acadian Asset Management (Singapore) Pte Ltd, (Registration Number: 199902125D) is licensed by the Monetary Authority of Singapore.

Acadian Asset Management (Australia) Limited (ABN 41 114 200 127) is the holder of Australian financial services license number 291872 ("AFSL"). Under the terms of its AFSL, Acadian Asset Management (Australia) Limited is limited to providing the financial services under its license to wholesale clients only. This marketing material is not to be provided to retail clients.

Acadian Asset Management (UK) Limited is authorized and regulated by the Financial Conduct Authority ('the FCA') and is a limited liability company incorporated in England and Wales with company number 05644066. Acadian Asset Management (UK) Limited will only make this material available to Professional Clients and Eligible Counterparties as defined by the FCA under the Markets in Financial Instruments Directive.