Goldman Sachs: Observations on the US Midterm Elections

The US midterm elections on November 6th resulted in a divided government—the widely expected outcome—with the Democratic Party gaining control of the House of Representatives while the Republican Party maintained their majority in the Senate. We believe the markets were largely priced for this outcome and therefore expect limited effect on market volatility.

Fundamentals and Policy Matter More than Politics

Financial markets care more about fundamentals and policies than politics, with markets showing greater resilience towards political events or rhetoric that produce little action. We believe the midterm result is no exception with a divided government likely to have a larger impact on political sentiment than market performance.

From a fundamental perspective, US growth remains on solid footing and the third quarter US corporate earnings season has been robust so far, characterized by strong earnings growth and earnings “beats” relative to consensus expectations running above the historical average. However, the market has sharply punishedearning misses and failed to appropriately reward beats—even before the midterm election outcome—as investors’ attention has shifted to 2019 when the fiscal tailwinds are expected to become less powerful and the impact from tariffs is expected to intensify pressure on corporate profit margins.

We think the election outcome is likely to produce few changes in US economic policy relative to what is already reflected in market pricing.

  • Fiscal policy: With Democrats gaining control of the House, we see limited potential for significant changes in fiscal policy. A divided government is likely to create political gridlock, lowering the probability of further US fiscal stimulus such as a middle class tax cut, while also making it difficult for Democrats to change existing policy. Without additional fiscal stimulus, we think markets could remain focused on the potential for a US slowdown in 2019. We think markets have already gone a long way to price in this scenario, creating upside potential for risk assets if incoming economic data remain strong.
  • Trade policy: The focus of the Trump Administration is now likely to shift towards securing re-election in 2020. Trade is an area where President Trump can continue to pursue his agenda through executive power. However, with limited potential for fiscal stimulus, the administration could look to de-escalate trade tensions as a way to support economic growth.

What We Are Watching

From a political perspective, we think two upcoming events could provide some insight on the potential for policy shifts. In the near term, the November G20 Summit could provide more clarity on the Trump Administration’s post-election approach to trade policy. Following that, the US debt ceiling could become an issue again beginning in March 2019, when prior legislation suspending the debt ceiling is set to expire. Historically, divided government has raised the risk of government shutdowns, with 2011 and 2013 serving as recent examples.

Source: Goldman Sachs