Having enjoyed support from both houses of Congress for the first two years of his presidency, Donald Trump will now face greater opposition after the Democratic Party secured a majority in the House of Representatives in this week’s mid-term elections.
While the elections played out broadly in-line with pollsters’ and fund managers’ expectations, the outcome is likely to impact the economy.
Under the pro-business administration of Trump the US economy has continued to expand and markets have reacted with strong growth latterly thanks to a package of tax reforms.
US GDP since Q3 2016
Source: Organisation for Economic Cooperation & Development
Andrew Hunter, US economist at consultancy Capital Economics, said the Democrats were widely expected to win control of the lower chamber with the stage now set for two years of “legislative gridlock”.
He said: “With Congress divided, Trump and the Senate Republicans won’t be able to make any major legislative changes without the approval of Democrats.”
While Trump could work together with the Democrats to boost infrastructure spending, said Hunter, “there is probably more chance of a government shutdown”.
“That said, the mid-terms will do little to derail Trump’s protectionist agenda,” he added.
Two years since the unanticipated victory of the divisive president, it remains unclear whether Trump continues to command as much support as he did as a political outsider during the presidential election.
“If this mid-term election was a referendum on Mr Trump’s presidency, the results were inconclusive,” added Ed Smith, head of asset allocation research at Rathbones, who said Trump could struggle in the second half of his term.
“Without a majority, Trump’s legislative agenda is dead in the water – basically most things which involve government expenditure and revenue.
“So possibly no further tax cuts, no big cuts to Medicaid or food stamps, no further repeal of Obamacare.”
However, Smith said things such as Trump’s tax breaks are unlikely to be reversed.
“We don’t expect a significant change in the size of the budget deficit, but at least a small redistribution away from the very wealthiest beneficiaries of Mr Trump’s tax plan seem inevitable,” he explained.
As such, what do the mid-term results mean for investors? Not a lot, according to Smith.
“Analysing the last 50 years, we find evidence that US equities tend to be rather directionless in the six months before a mid-term election – much like this year – with a little extra volatility – again, much like this year,” he said.
“Over the subsequent six, equities tend to rise steadily. But here’s the rub: it doesn’t seem to matter one jot whether or not either party loses, gains, keeps or never had control of Congress in the first place.”
Performance of index over past six months
Source: FE Trustnet
During the past six months, the S&P 500 has risen by just 3.46 per cent in US dollar terms, as the above chart shows.
“A divided government has some positives for markets in that the more extreme policies of the Trump presidency will certainly see some push-back which financial markets are clearly seeing as a positive,” said Jake Robbins, manager of the Premier Global Alpha Growth fund.
“The great fear was a surprise hold by the Republicans in Congress which would have allowed Trump’s combative foreign and trade policies that have so unnerved markets to escalate further.
“Financial markets are breathing a sigh of relief that this is not the case.”
He added that sectors such as basic materials, semi-conductors and industrials – which were hit hardest by tariffs – should see some respite, especially as their underlying growth prospects have remained pretty good and they look attractively valued after the sell-off.
While the split in Congress makes agreement on further expansionary policies highly unlikely “there are no looming recessionary clouds on the US medium-term economic horizon”, according to Nick Watson, a fund manager on the Janus Henderson’s multi-asset team.
The multi-asset specialist said investors should expect a more conventional late-cycle US economy and lower return expectations.
“We have also got used to the US dragging all other markets along with it and investors blindly buying dips in the S&P 500 – the next couple of years may be more about non-US equities and a more considered approach to taking risk,” Watson explained.
“Therefore, unfortunately it is likely to mean more volatility but on the flip side, a greater focus on valuation, fundamentals and diversification; an environment which should present a better environment for stock pickers and asset allocators.”
Nick Wall, co-manager of the Merian Strategic Absolute Return Bond fund, believes markets are witnessing the “end of US exceptionalism” giving global growth the chance to resynchronise – albeit at levels lower than 2017.
“The US is running large twin deficits, and textbooks suggest should lead to a weaker currency,” he added. “However, high front-end yields and strong growth meant that capital inflows kept the US dollar overvalued this year.
“This strong dollar, the world’s predominant funding currency, has led to higher volatility in the rest of the world.
Performance of IMF reserve currencies in US dollar over 5yrs
Source: FE Analytics
“As the effects of stimulus wane, and with the potential for a trade war thaw, we expect to see US risk assets and the US dollar underperform versus the rest of the world as capital flows back out of the US – a not unwelcome development.”
Another potential impact of a split Congress is the potential damage it could do to Trump’s hopes for a second term in the 2020 presidential elections.
Without bicameral support, Trump will have fewer options to accelerate economic activity and boost business confidence and financial markets, according to Janus Henderson’s Watson.
“Therefore he may instead double down on areas he can control without input from the Senate and Congress – specifically foreign policy, trade and the level of antagonism from his Twitter account,” he noted.