Trading the 2018 US mid-term elections.
Asian markets may be focused on the potential fall-out from global trade wars, whilst Europe juggles not only with this challenge but also faces the added complication of the UK’s awkward attempts to find a way to extract itself from the European Union trading bloc. The scale of each of these events is arguably without precedent and as such at times can be difficult for traders to try and call, but in the USA there’s what’s should be a rather more text-book political event looming in the shape of the US mid-term elections. They will take place this year on November 6th, but just what should we expect - and will things be different this year?
So, what are the mid-terms?
Although the US President is voted into office every fourth year, members of the House of Representatives are elected on two-year terms. The picture is further clouded by Senators standing for six-year terms, with one third of the lawmakers facing election every second year. We’re half way through the Presidential term, hence the mid-term moniker. It’s also typically seen as a vote of confidence - or otherwise - in the President’s performance to date.
At present, we have President Trump in the White House. He has a slightly uncomfortable relationship with Republican Party, who in turn currently have a majority in both the House of Representatives with 235 out of 435 seats and in the Senate, where they control 51 of the 100 seats. The question is whether the balance of power amongst lawmakers will change.
So let’s cut to the chase.
It’s fair to say that President Trump has been a divisive character in US politics over the last few years. We’ve seen the first publicly traded trillion dollar companies created with Apple - and intermittently Amazon - as a result of his tax breaks on allowing US businesses to repatriate cash. The stock market has been flying and unemployment remains low, but many voters are said to be tiring of the President’s approach to diplomacy. What’s more, it’s the rich who are getting richer - for example, a NYU paper published at the end of 2016 showed that the top 10% of Americans by wealth own 84% of all US stocks.
As such, there’s a growing belief that the electorate wants a change of tack. The President isn’t going anywhere, but if the opposition Democrat party can gain a majority, then it’ll make Trump’s plans harder to deliver. Change seems inevitable, but what will the political make up of Capitol Hill look like once the votes have been counted on November 6th?
There’s no shortage of analysis over what might happen at the ballot box but with Donald Trump’s approval ratings so low, some loss of seats seems inevitable. There’s just as much narrative about how the outcome might play out with regard to the success of the US economy in the longer term, but we have the genuine risk that a split congress will be seen, with opposing parties in control in either house.
Enough of the politics - what does this mean for markets?
What this all adds up to however is uncertainty before the event and it’s a well reported fact that this quality certainly isn’t one markets embrace. But does this hold true for the mid-terms? Looking at the VIX volatility (or fear) index over the last five mid-terms suggests not.
Although if we rebase the VIX, so we’re looking at the variance from one month before the mid-terms, the picture looks a little different.
Whilst past performance can never be taken as a guide to future results, it’s worth noting that in 1998 and 2002, there was no “mid-term wave” - that’s when the incumbent party lose more than 20 seats across both houses - presidential approval ratings were high and market volatility was on a downward trajectory throughout the October/November period. In the years where we did see that mid-term wave - 2006, 2010 and 2014, all coincidentally when presidential approval ratings were below 50% - volatility still fell over the two month period, but remained heightened. Note that the spike in October 2014 is attributed to fears at the time of another global economic slowdown as the IMF dialled down growth forecasts.
An added complication this time round is that the “Republican” President is employing some interventionist trade policies that would typically be welcomed by the Democrats. On top of this we have the fact that concern over a potential backlash for markets from the escalating trade disputes remains front of mind for many - but up to now we haven’t seen any meaningful or sustainable hit here.
However, if look at the performance of the US30 for the month before and after the mid-terms, an interesting pattern emerges.
The outperformance in 1998 and 2002 is notable - and critically in both of these years the mid-term wave wasn’t observed. For the other three observed cycles, the US benchmark index struggled to make any headway at all in the wake of the election.
It might be easy to believe these mid-terms will be the harbinger of doom - and granted the politics of Donald Trump are a very different form of diplomacy to what we’re accustomed to - but with analysts on the fence over just how big of a swing we’ll see to the Democrats, a less than impressive performance by the liberals could simply be the next leg-up for the seemingly endless equity market rally. History tells us it will come to an end at some point - the question remains how long we’ll have to wait.
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Too much uncertainly in the world