Investment Insights: Midterms and the markets

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Closeup on a 2018 red-white-and-blue button in a pile of similar patriotic election buttons.The U.S. midterm elections came to a close late last night after Americans across the country took to the polls in high numbers.

The results show that Democrats seized the majority in the House, for the first time since 2010, while Republicans were able to increase their slim majority in the Senate. Political pundits had predicted a potential “blue wave” could sweep the nation – with results skewing heavily toward Democrats. But that prediction did not totally come to fruition with the newly split Congress. Much of the expectation was based on voter sentiment toward both Congress and the White House leading up to the elections. While presidential approval ratings do seem to play a part in elections, broad congressional support hasn’t really been an issue for years. According to Gallup, congressional approval ratings have averaged 18% since 2008, with the most recent poll from October showing a 21% approval rating.

Domestic stock markets had hunkered in on Election Day as investors waited for the outcome, with the S&P 500 gaining just 0.63% on Tuesday despite outstanding earnings numbers. Meanwhile, the 10-year Treasury climbed to 3.23%. The results of the election will definitely set a tone for the markets going forward as the pro-business policies that have dominated lawmaker agendas may face political gridlock. It will also likely make things a little more difficult for President Trump as he will need to do one of two things: further compromise on his policies, or face a possible stonewall in the House. The market reaction has been fairly positive so far, but investors may be a little more wary over domestic affairs, at least for the next few years.

The U.S. earnings machine continues to churn out stellar results this season. The number of companies within the S&P 500 that have reported their figures has reached 419, and profitability has surpassed expectations. According to Bloomberg data, these corporations have beat earnings estimates by an average of over 6.50%, and earnings growth is over 27% – even beating the last two quarters, which saw some of the largest increases ever. While earnings have done incredibly well, the market doesn’t seem to be taking these increases into consideration and advancing as expected. That may be due, in part, to challenges companies are facing on the revenue side and their earnings outlooks. So far, sales are beating forecasts by their lowest amount since the fourth quarter of 2016, and numerous bellwethers have begun to set lower expectations for the coming quarters.

We have not substantially changed our view that stock markets will continue to outperform bonds, for the time being. However, there is a growing concern that earnings are not driving stock returns in this phase of the cycle, as much as they have historically in the recovery. This change seems to also support our belief that geopolitical events and the rise of protectionism continue to exert more and more influence over financial markets, therefore becoming a potentially greater risk. This seems particularly true in the global theater as issues like Brexit and trade conflicts loom. Similar to some of the companies providing lower guidance, our team is seeing increasing odds of lower growth on the horizon.

Chart showing various market returns as of 11/6/18

Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

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