The three big questions for investors thrown up by US mid-term elections

This vote was more significant than usual, and Trump has lost control of the House, but what does it mean for financial markets? Tom Bailey reports.

As was widely predicted, the Democrats took hold of the House of Representatives, the lower chamber of Congress, in the US mid-term elections. Meanwhile, the Republican Party has managed to retain control of the upper chamber, the Senate, increasing its majority.

Here, we run through the possible implications as far as investors are concerned.

1) Will the US economy get a fiscal boost?

Alongside promising tax cuts, President Donald Trump has regularly spoken in favour of a large national infrastructure investment programme.

Democratic leader Nancy Pelosi has made it clear that her party supports increased spending on infrastructure, noting that it is a rare bipartisan issue on which she believes Democrats and Republicans can work together.

An infrastructure plan may prove positive for markets, which are generally welcoming of increased fiscal expansion. At the same time, industrials and materials are likely to see stronger performance on the back of such infrastructure spending hopes.

Yet with the US economy already racing ahead, further economic growth raises the spectre of faster rate rises from the Federal Reserve, something that spooked investors in October.

Economic stimulus, says Paras Anand, head of asset management at Asia Pacific, Fidelity International, would "continue to push wages in an already tight labour market, and potentially challenge the current expectations around the Federal Reserve's activity for next year".

At the same time, notes James Rowlinson, head of fund selection at Mazars: "The combination of a Democratic House eager to pass some legislation, but unlikely to cut any entitlement programmes, and a president for whom fiscal responsibility is clearly not a priority, could be further detrimental to the nation’s debt pile, potentially sending Treasury yields higher."

And, as was seen during the October sell-off, spiking Treasury yields can be bad for markets.

2) Or will political gridlock hold up any spending plans?

However, an expansion in fiscal spending is not a given.

First, progress on infrastructure may fall victim to party politics. Despite both sides agreeing on the need for more investment in infrastructure in principle, the type of infrastructure needed is still a partisan issue.

As Rowlinson observes: "Democrats [are] likely to be focused on transport, while Republicans [are] more interested in energy infrastructure.” This disagreement could hold up any such spending.

At the same time, Democrats may be cautious of supporting a Republican-led infrastructure plan, fearful that it may be throwing Trump a bone ahead of the 2020 presidential election.

As Jordan Rochester, a strategist at Nomura, notes:

"We think a Democrat House will be reluctant to support initiatives that Trump could use to advance his re-election chances in 2020."

Added to this, the US is now less likely to see fiscal expansion in the form of tax cuts. Trump’s tax reform, passed at the end of 2017, helped fuel strong earnings growth, and therefore share price growth, in 2018.

A win for the Republicans in both the House and the Senate could have seen these tax cuts extended further. With a Democrat win in the House, any such plans are likely to be shelved.

If such predictions ring true, and the US does experience less fiscal stimulus, that could mean a less hawkish policy from the Fed, which would prove positive for global equity markets.

As Richard Buxton, head of UK equities and manager of the Merian UK Alpha fund, points out:

"The Federal Reserve will have less work to do. That would be good news for emerging markets – with fewer rate rises ahead and a dollar that’s not so strong. This, in turn, would provide some relief to emerging markets."

3) Will the US/China trade war cool off?

Although grappling with China's economic ascendancy was a primary talking point for Trump during the 2016 election campaign, this election's outcome is unlikely to change the current course of US and China relations.

First, despite criticism of his bellicose rhetoric, most Democrats broadly agree with Trump taking a tougher stance on China. As Nick Wall, co-manager, Merian Strategic Absolute Return Bond Fund, notes:

"Belief that China has engaged in unfair trade practices is not purely a Republican trait."

At the same time, trade policy is more the responsibility of the Executive, not Congress.

The future of US/China trade relations hinges more on the scheduled meeting between Trump and China’s president, Xi Jinping, in Buenos Aires at the end of November.

Recent comments from both sides have given investors reason to be positive that some form of compromise will be reached.

Trump recently tweeted of having a "productive" conversation with Xi in regards to trade. Meanwhile, speaking at the Bloomberg New Economy Forum in Singapore, China's vice-president Wang Qishan said:

"The Chinese side is ready to have discussions with the US on issues of mutual concern and work for a solution on trade acceptable to both sides."

However, investors shouldn’t hold their breath. While some sort of agreement may be reached, the wider question of how the US deals with an increasingly powerful China - both economically and militarily - will persist. The US now openly talks of China a strategic rival and the Chinese economy's growth as a national security concern.

Meanwhile, despite some criticism of Xi within China over the handling of the trade war, the dispute has confirmed in the eyes of the Chinese that the US is attempting to prevent China's rise.

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