The Midterm Results are In, What’s Next?
With Congress divided, our U.S.-based team of analysts argues that regulators, not legislators, could do the most to influence the U.S. investment environment.
- The U.S. midterm elections gave the Democrats control of the House and the Republicans the Senate, a result that could limit the legislature’s ability to push either party’s agenda.
- In our opinion, this balance of power could limit further tax cuts and help keep federal deficit levels relatively contained.
- At the same time, we believe the majority of policy making will rest with regulatory agencies, which throughout the Trump administration have tended to drive most reform.
Tuesday marked the hotly contested U.S. midterm elections with both branches of Congress and several governorships in play. As was largely anticipated, Democrats wrested control of the House of Representatives, while the GOP maintained its majority in the Senate. Conventional wisdom argues that a divided government will lead to legislative gridlock, with the corresponding stasis beneficial to financial markets. But we believe Tuesday’s results will have only a marginal impact on the investment landscape and the broader economy.
We base our rationale on the fact that the lion’s share of policy making has shifted from the legislative branch to the executive. This has placed substantial power to shape policy in the hands of regulatory agencies. Many of these agencies are now headed by appointees of President Trump, and as the party that holds the White House, the GOP enjoys majority positions on the commissions mandated to implement laws passed by Congress.
Still, the election does have consequences. Committee chairs in the House will shift to Democrats. We expect the new House leadership to be proactive in holding hearings where they will scrutinize the actions of regulators. Consequently, the deregulatory push that the Trump Administration has championed may face rising headwinds. We expect, however, that any impact may be marginal as the regulatory process is slow-moving and many of the initiatives currently in the works will likely stay on course. In addition, although the Trump Administration has signaled its interest in pursuing further tax cuts, we believe the Democrats are likely to block those efforts. In our opinion, this will help keep deficit levels and Treasury issuance relatively contained, which could potentially be beneficial for U.S. rates.
Long-term investors should seek to identify companies that can perform well in all market cycles and regardless of who is in charge in Washington. Yet, as recent elections have proven, policy does shape the playing field for businesses. With that in mind, our U.S.-based team of analysts provide insight into how Tuesday’s results may impact the sectors they cover.
Financials: Staying the Course
- The financials sector is a prime example where much of the policy making that affects it is regulatory-driven. President Trump’s appointees now control many of the agencies that oversee the sector and the election results will change neither agency leadership nor their agenda.
- We expect that these agencies’ incremental deregulatory push will continue. An example is the effort to loosen the directives placed on small- to medium-size banks by Dodd-Frank. The process, however, is slow by design and the current crop of administrators, while taking a more industry-friendly stance, still want to be perceived as tough on malefactors.
- The president has the authority to appoint members of the Federal Reserve’s (Fed) Board of Governors. While some chafe at President Trump’s criticisms of Fed policy, we believe that the central bank takes its independence seriously and will act accordingly. We do not see the shift in House control as having any meaningful effect on the president’s interaction with the Fed or with the bank’s execution of monetary policy.
Energy: A Drilling Restriction Defeated
- On the federal level, we see little in yesterday’s results that would directly impact the energy sector. We expect the national regulatory environment to continue to be benign for oil and gas companies given that President Trump has been largely supportive of the energy industry. As with other sectors, Democratic committee chairs may be more assertive in exercising regulatory oversight, but much of granular policy formation lies within the executive branch.
- In contrast, the ballot measure that had the greatest potential impact on energy occurred in Colorado, where a proposition to greatly inhibit new drilling was defeated. Among U.S. states, Colorado is one of the top 10 producers of oil and natural gas, and passage of this measure could have sent shockwaves across the sector as movements in other states may have been incentivized to follow suit.
- Exploration and production companies with heavy exposure to Colorado and the midstream companies servicing them have had clouds hanging over the stocks in recent months, given the tightness of the polling. A victory for the proposition would have likely pressured these companies’ stocks and bonds further.
Health Care: Reform Likely to Continue
- Health care was a major issue pushed nationally by Democrats. It rallied the party’s base, while at the same time President Trump’s failure to repeal the Affordable Care Act (ACA) put some Republicans on the defensive. Given Tuesday’s results, we expect health care to again be a central issue in the lead-up to the 2020 election but that a major repeal of the ACA is now completely off the table.
- President Trump also set his sights on prescription drug prices by rolling out the administration’s “blueprint” to lower drug prices in May and, more recently, suggesting changes to Medicare Part B. Ongoing rhetoric from both parties about lowering drug prices could create headline volatility for the sector. However, we believe the impact to drug companies’ revenues in the near term will be minimal, while efforts to improve patients’ ability to afford prescription drugs are beneficial to the sector in the long term.
- With Congress divided, we believe further changes to health care policy will continue to be pursued through regulatory channels. So far, these efforts have focused on improving efficiencies within the health care system, lowering out-of-pocket costs for consumers and encouraging market competition, and we expect to see more of the same in the years ahead.
Technology: The March Toward Internet Privacy
- We do not believe the election’s outcome will have a significant bearing on the regulatory environment governing the tech sector. This is, in part, due to both Democrats and Republicans being broadly aligned in the march toward greater consumer protections concerning Internet security and privacy. Europe took the lead on the issue earlier this year with the rollout of the General Data Privacy Regulation (GDPR). California subsequently passed its own stringent requirements, which may serve as a harbinger for other states to follow suit.
- So although Tuesday’s results don’t represent a sea change in the regulatory landscape, we must be mindful of the incremental advancements of greater regulation of Internet platforms. By their nature, search companies’ algorithms run off the information that users put into the search function. For now, we don’t see a major threat to this business model. Social networks, on the other hand, hold a tremendous amount of user data and therefore are riper targets for privacy advocates. We are closely monitoring changes in privacy/security regulations and how they may impact these companies’ advertising-based revenue models along with the potential for rising compliance costs.
- Similarly, a shift in control of the House might do little with regard to tariffs as both parties are adopting less trade-friendly stances. While President Trump espouses more pronounced anti-trade rhetoric, both parties seem largely in agreement that certain aspects of the U.S.-China economic relationship – namely intellectual property rights – must be addressed and, thus, we would not expect significant pushback from House committee chairs on many trade-related issues. The semiconductor industry appears to be at the bull’s-eye of trade relations, with global players already adjusting supply chains to compensate for this new reality.
Industrials: Stakes Rise for Global Trade
- The midterms are unlikely to hold much sway over trade disputes. However, with votes counted, future negotiations may now focus more on the economics of global trade than political implications.
- Finding a resolution is becoming increasingly important. During the latest earnings season, a growing number of industrials companies began to quantify the potential impact to profits should tariffs become more punitive in 2019. For some companies – particularly those that source subcomponents in China – the pain is already real, with costs rising significantly in 2018 because of tariffs.
- More positively, infrastructure spending could be one of the few issues to garner bipartisan support in Congress. The future of defense spending is less known: Before the elections, President Trump reportedly warned the Pentagon to lower its fiscal year 2020 budget in the event that Democrats gained more seats in Congress. However, should trade tensions between the U.S. and China boil over, we think it is unlikely that defense spending eases in the immediate future.