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Investing After the US Midterm Election

At the time of writing, the Democratic Party has won 222 seats out of 435 in the House, securing the 218 seats required for a majority in the chamber. It is the first time the party has held the majority in the lower house of Congress for eight years

In the Senate, the Republicans have held on to their majority, in what was a tight race. With 51 out of 100 seats, the Senate remains under Republican control.

The loss of the House by Republicans — President Trump’s party — could be seen as a partial referendum on the Administration’s performance to-date. The President has signaled that he will continue to pursue his domestic and foreign agendas.

As the election outcome matched investors’ expectations, Citi analysts anticipate a muted response from markets over the next few days. Market reactions may change as the Congressional priorities become more apparent over the next few months.

 

What are the implications for the US Economy?

The US economy should continue to benefit from Tax Reform 1.0 and improved prospects for a bipartisan infrastructure deal within the next two years. However, trade uncertainties, investigations and impeachment threats are downside risks.

Congress is likely to come to bipartisan decisions to raise the debt ceiling and delay the 2020 fiscal cliff. However, fiscal discipline might become an important reelection issue for President Trump, posing risk to passage of these key bills.

The divided Congress result is unlikely to cause a material change in President Trump’s foreign policies. Indeed, Democrats may support President Trump’s tough trade stance, given the party’s history of skepticism towards free trade policies.

Along with trade tariffs, sanctions may likely remain a favored foreign policy tool of the Trump Administration. Domestically, deregulation, immigration, and security may probably also remain top focuses for President Trump over the 2019-20 span.

 

What are the implications for Equities?

US: Following tax cuts and deregulation, US large caps’ expected long-term earnings growth has caught up with small cap stocks which, in turn, have also seen their higher debt burdens weigh on relative performance as rates have risen. As we advance deeper in the business cycle, Citi analysts would prefer to upgrade the quality of their portfolio holdings. Large caps are less volatile than small caps and dividend growers have historically performed competitively with less risk than the market at large.

 

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Emerging Markets: Citi analysts also look to take advantage of the opportunities in Emerging Markets trading at deep valuation discounts and higher dividend yields than US stocks. Asia, in particular, offers positive longer-term economic prospects – contributing to a forecasted 12% earnings-per-share growth.

 

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Infrastructure: In addition to solid risk-adjusted performance and high dividends, infrastructure stocks have been less sensitive to trade developments given the relatively domestic nature of many physical and digital investment projects.

 

What are the implications for currencies?

While the USD weakened during Wednesday Asia trading (dollar (DXY) Index down nearly 0.6% from a high of 96.46 to 95.90), it recouped some of its decline during London/NY trading. As of Thursday morning Asia time, DXY was at 96.00, down only (0.3%) from its pre-election levels.

The USD is expected to weaken over the next few months driven by rising US political tensions following the Democrats win. At the same time,  FX markets will also be driven by a number of other events in Nov/Dec – 1) Brexit negotiations 2) US-China trade negotiations 3)  Italian budget discussions. Given these events, FX market volatility is expected to continue at current levels through November.

 

 

Conclusion

Following the US midterm election, investors will still need to navigate through trade tensions, Brexit, central bank developments and a host of other issues.

In a mature bull market environment, Citi analysts believe it is even more important to have a diversified portfolio and take advantage of favorable fundamentals and valuation readings, which can help investors chart their course as these events unfold.

 

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