The US mid-term elections this week will provide a judgement on president Donald Trump’s first two years in office. All 435 seats in the House of Representatives and 35 of the 100 seats in the Senate will be contested. The big issue is whether the Republicans will retain control of both houses; or whether one or both will fall into the control of the Democrats. In the latter case, the ability of president Trump to implement new policies would be curtailed; although overturning those already implemented would be difficult. 
It is unusual for the mid-term elections to see seats gained by the party of the incumbent president (see graph below). 
That has only happened twice since 1982: in 1998 (when president Bill Clinton was in office) and in 2006 (when George W. Bush was president). Both of those presidents had a very high approval rating and were in their second terms at the time; in both cases the economy and stock market were strong.
President Trump’s approval rating is low – lower than that of any other president since the early 1980s. Yet, in common with the Clinton and Bush mid-term elections, the economy and stock market are strong. A simple, albeit weak, relationship between approval rating and seats gained or lost (in both houses) suggests that the Republican party could lose as many as 50 seats. A more detailed analysis shows that 43 seats in the House of Representatives and seven seats in the Senate are hard to predict. The number is relatively low because, in the mid-term elections, many seats are safe and voter turn-out tends to be quite low.
In that sense, losing 50 seats may be considered a ‘worst case’ for the Republicans. However, the 2016 presidential election itself showed just how unreliable standard polling techniques can be in predicting electoral success. President Trump pulls many surprises.
Tariffs and China
If president Trump’s first year in office can be characterised as one in which he failed to deliver on many of his election promises, the second year has seen a big catch-up, especially in the area of trade and tariffs.
The latest round of tariffs on China came into effect on 24 September. They are imposed on almost $200bn of imports from China, at a rate of 10 per cent. President Trump intends to raise the rate to 25 per cent on 1 January 2019 if a trade deal between the two countries is not reached. China has retaliated and the vast majority of Chinese imports from the US are now subject to tariffs.
Although most economists would say no one wins in a trade war, president Trump clearly takes a different view. The stock market is his favourite barometer of success and on that basis, the US is ‘winning’. China’s main stock market index is down over 20 per cent for the year-to-date, whereas the S&P 500 index recently reached new highs and is one of the few equity indices to have delivered positive returns so far this year. Furthermore, China’s economic growth has slowed recently, whereas US growth has picked up. The US unemployment rate is at new lows and many voters have seen the benefit of personal income tax cuts this year.
A simple message that tariffs on China protect US growth and jobs, even though there is almost certainly no causal relationship, may well prove to be effective for president Trump in the up-coming midterm elections.
Can this last?
There are already signs that world growth is slowing and at least some of this is due to the disruption of global trade flows. In the 24 September tariff round, the goods covered are more difficult to replace with US domestically produced goods so may well have a more disruptive effect on supply chains. Furthermore, US dollar strength will act as a headwind to US exports.
These developments may well start to constrain US economic growth and, we think, could lead to a tempering of the rate at which US interest rates are increased. That could mean that the increase in government bond yields seen recently may already be discounting the likely increase in short-term interest rates that will take place in the Fed’s tightening cycle. If that proves to be the case, then the pressure which a stronger dollar and higher US borrowing costs have exerted on emerging markets may well ease as we move into 2019.
US equity market
If that were to happen then it may well also provide support for the US equity market. One major source of support this year has been the extent of stock buy-backs. Total authorised stock buy-backs stood at $741bn in the year to end-July, the highest ever amount, according to Birinyi Associates.
Looking in a much longer-term context, the general pattern has been for long, essentially sideways movements in the market to be followed by long periods of appreciation.
Moz Afzal is global chief investment officer of EFG Asset Management. The views expressed above are his own and should not be taken as investment advice.