Investors in U.S. equities should welcome the U.S. midterm election outcome, which saw the Republican party narrowly gain majority control of the House of Representatives while the Democrats held on to their slim Senate majority.
That means Congress’s two houses will have the votes to block each other’s legislative or fiscal initiatives before they reach the desk of President Joe Biden.
“Markets hate uncertainty,” said Greg Valliere, chief U.S. policy strategist with Toronto-based AGF Investments Inc. “When you have the parties this tightly gridlocked, it means there won’t be a lot of stuff the markets have to worry about.”
Also viewing the political gridlock as a positive for the markets is Strider Elass, senior economist with First Trust Advisors LP, a U.S. affiliate of Toronto-based First Trust Portfolios Canada: “That means we’re not going to see any big new spending packages go through or any new big tax hikes over the next couple of years, and I think that’s going to bring more certainty.”
Paul Eitelman, chief investment strategist for North America with Seattle-based Russell Investments Group LLC, said the midterms’ outcome is unlikely to meaningfully affect the nation’s fiscal or economic outlook. He said the rebranding of Biden’s signature Build Back Better bill to the Inflation Reduction Act “suggests to me the days of big U.S.stimulus were already over, irrespective of who is in power.”
It’s been a rough year for U.S. equities, with the S&P 500 composite index losing 14.4% for the year to Nov. 30 in U.S.-dollar terms. Many U.S. equity funds in Canada did much worse, including some that were heavily weighted in growth stocks.
History suggests better times lie ahead. According to data compiled by First Trust Advisors, the S&P 500 has had positive returns in the 11 months following the November midterms for each of the 18 midterm election years dating back to 1950. The average 11-month return was 17.7%.
The post-midterm calendar-year streak is even longer. Dating back to 1934, one-year returns have consistently been positive in the year following the elections, Eitelman said. Tending to perform even better were markets in which there was a Democratic president with a Republican or split Congress. “That might be a random artifact of history, or it might show that elections resolve uncertainty — and markets don’t like uncertainty.”
Far more important market drivers, Eitelman added, are the U.S. Federal Reserve’s continued war on inflation, the slowing of leading economic indicators and double-digit losses in the equities and bond markets. Another looming potential risk is demand by Republicans for spending cuts in exchange for lifting the federal debt ceiling.
“As unlikely as a technical default is, the headlines and volatility from political brinkmanship might make an unwelcome comeback,” Eitelman said.
Elass predicted that to get inflation under control, the U.S. will have to go into a recession sometime in 2023.
“We believe there’s not going to be a soft landing,” he said. “And so we don’t see the market as having bottomed yet, probably until we’re at least in a recession in the United States.” From there, he added, “we’ll eventually hit new all-time highs.”
During a post-election webinar for Canadian financial advisors, Elass pitched First Trust’s buffer U.S. equity ETFs, which provide S&P 500 exposure but are designed to protect investors against the first 10 percentage points of a market decline.
In addition, BMO Asset Management Inc., Brompton Funds Ltd., Harvest Portfolios Group Inc. and Horizons ETFs Management (Canada) Inc. are among the manufacturers offering covered-call ETFs with exposure to U.S. equities. Covered-call writing, while reducing potential capital gains, can also reduce risk while generating tax-efficient premium income.
For long-only U.S. equity products, Elass recommends exposure to value-oriented, high-quality companies that continue to be profitable and pay dividends. He also favours sectors that are likely to outperform in the inflationary environment that he expects to persist for at least the next couple of years.
“We still like materials, industrials, commodities, energy, financials,” Elass said. “Those are all areas that we’d be overweighting in this market environment over the next 12 to 18 months.”