The American people have spoken

9 November 2018

It struck me this week how full of historic events the first weeks of November are. Guy Fawkes’ gun powder plot (1605), the end of WWI (1918), The German Revolution of 1918 – abdication of Kaiser Wilhelm II, the Reichskristallnacht pogrom against the German Jews (1938), the fall of the Berlin Wall 1989, etc. and then the election of Donald Trump (2016). This year’s US Midterm elections had historic significance but are less likely to feature heavily in future history books. Historic significance because their outcome would show whether Donald Trump’s 2016 election as president of the United States was an ‘accident of circumstances’ or a permanent shift of the US electorate towards more extreme political positions.

The 2% gain of the US stock markets in reaction to the result of Tuesday’s elections tells us that the outcome was acceptable for both sides and perhaps the best that could be hoped for the economy. As predicted (but with much less conviction than usual), Trump’s Republican party lost the House of Representatives (lower house of the US Congress) but gained seats in the Senate (the upper chamber of the US Congress). Both sides were therefore quick to claim victory. More importantly for the economy, the loss of full control of Capitol Hill means that Trump will be subject to increased congressional scrutiny, which should prevent some of his more outrageous policy initiatives from becoming law (the border wall with Mexico for example). On the other hand, confirmation of his government appointments through the Senate should become much easier, which will appeal to his ‘The Apprentice’ style high staff turnover approach. The risk is that he might quickly dispose of the remaining ‘adults in the room’ which, in the case of defence secretary Jim Mattis and White House Chief of Staff John Kelly, would likely prove destabilising.

For the near-term prospects of the US economy, however, not too much should change, given the Democrats are not known for fiscal constraint and have also historically tended to be more supportive of protectionist trade policies than the Republicans. What may improve is the general sentiment and outlook amongst voters of the Democrats. They will have taken heart from the fact that they clearly won the popular vote in this election, as all members of the House of Representatives were up for re-election and their seats are allocated to the states roughly proportional to their population. Only one third of the Senate is re-elected every 2 years, with every state being represented by 2 senators regardless of a state’s population. With the bulk of the Democrats’ support coming from the densely populated states and conurbations along the coast lines and the Great Lakes, it is almost inconceivable that Trump will ever lose the Senate.

What is almost more important though is that a majority of voters decided to vote against Trump’s Republicans despite the economy enjoying some of the best growth and lowest unemployment in recent history. Some therefore interpreted this win of the Democrats as a far more decisive victory over Trump’s style of politics than the relatively small shift in political power would otherwise indicate.

Beyond the US, this relative defeat of populism might also reinvigorate politicians in other western democracies who over the last 2 years failed to lead effectively out of fear of the populist surge among electorates.

Turning back to the economy and capital markets, the beginnings of a stock market recovery after October’s relentless falls was welcome but may not last. Just like in February, this correction has – at least from a technical perspective – not yet run its course and many technical indicators have once again turned negative. Only steadier upward market action will establish a solid base from which de-rated equities can rise back to levels more aligned to their current and future earnings expectations.

As we have written here before, current capital market volatility is driven by changes in the availability of monetary liquidity, rather than underlying corporate earnings, which have been very strong and stable. The double impact of a credit crunch in China and ongoing monetary tightening by the US central bank have put direct selling pressures on capital markets while also raising concerns about the sustainability of the volume of global credit. Only a very gradual further increase in interest rates and longer-term bond yields will lead to an orderly unwind of the very extended bond markets and prevent a bond market riot – which could constitute a cycle ending external shock.

We are observing these pressure points very closely and are at the moment pleased to see that the changes to the political setting in the US have neither had a particular effect on the US$ nor on the longer US bond yields. The slight strengthening of £-Sterling against the Euro on the other hand appears to indicate that the chances for reaching constructive Brexit terms may have increased. Looking at the necessary political majorities, we dearly hope the currency markets know more than we can currently make out.

What is almost more important is that a majority of voters decided to vote against Trump’s Republicans despite the economy enjoying some of the best growth and lowest unemployment in recent history. Some therefore interpreted this win of the Democrats as a far more decisive victory over Trump’s style of politics than the relatively small shift in political power would otherwise indicate.

Turning back to the economy and capital markets, the beginnings of a stock market recovery after October’s relentless falls was welcome but may not last. Just like in February, this correction has from a technical perspective not yet run its course and many technical indicators have once again turned negative. Only steadier upward market action will establish a solid base from which de-rated equities can rise back to levels more aligned to their current and future earnings.

We are observing these pressure points very closely and are at the moment pleased to see that the changes to the political setting in the US have neither had a particular effect on the US$ nor on the longer US bond yields. The slight strengthening of £-Sterling against the Euro on the other hand appears to indicate that the odds for reaching constructive Brexit terms have increased. Looking at the necessary political majorities, we dearly hope the currency markets know more than we can currently make out.