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Profit & Loss - Midterms Remind Us Why Gridlock Is Good

Investing

By now we know that the Democrats took the U.S. House of Representatives and Republicans held the Senate – all of which was the general expectation heading into the midterm elections.

This political shift potentially opens the door for four major policy changes in the areas of infrastructure, healthcare, immigration and trade. All of these may have a meaningful impact on the economy and the stock market.

This shift brings to mind the oft-heard mantra that “gridlock is good” when it comes to stocks. It comes from the notion that the likely inability of lawmakers and the president to accomplish much means politicians won’t be able to do much harm, nor undo market-lifting measures already in place.

It seems the easiest strategy for Democrats may be to endorse a permanent extension of the middle-class tax cut that would be funded by higher taxes on upper-income taxpayers and corporations. But such a strategy may be met with opposition in the Senate.

The following is an overview of some possible policy changes.

Infrastructure

Democrats could support allocating more money into infrastructure, but with money already tight and a shortage of workers in the labor force, it may be difficult to get a large infrastructure bill passed. But, a smaller, more direct, bill with regard to electric and internet grids may be able to find traction in the House and Senate.

HealthCare

With the elimination of the individual mandate taking effect in 2019, the House could push for a bill that may limit drug price hikes and address the opioid epidemic or come to an agreement with Republicans to help the states fund the shortfall in exchange-run health plans. Again, they may run into budget limitations for increasing funding to these state-run exchanges.

Immigration

With the House flipping to Democratic control, the Trump Administration’s push for a border wall seems less likely. But without a proper immigration policy, this could further increase the current shortage of workers in the U.S. economy and lead to slower economic growth in the next few years.

Trade

President Trump has taken a strong stance against China, with no end in sight to this position. In my opinion, the ongoing trade conflict with China may have negative ramifications on both the U.S. and global economy. This could leave President Trump vulnerable in 2020 if slower economic growth is tied to his administration’s handling of trade negotiations with China.

Summary

If they so choose, the Democrats should have the ability to extend tax cuts to the middle class or increase funding for healthcare and infrastructure. However, they also likely wouldn’t want to accomplish anything that would boost the economic clout of President Trump ahead of the 2020 elections.

It’s also important to point out that any additional stimulus created by Congress will be a move in the opposite direction of the Federal Reserve position towards raising interest rates. The Fed will need to find a balance in its target for the Federal Funds Rate to not elevate the strength of the economy. In this case, growth could be slower in the short term, but the ongoing economic expansion could last longer.

If history is any indicator, federal government gridlock could produce double-digit returns in equity markets. But every Congress is different, and every market environment is different. Investors need to remember that the U.S. is going into the 10th year of this bull market rally and they should take an honest view at their portfolios, diversification strategy and risk tolerances.

In this late stage, action or inaction from Congress and the Federal Reserve may alter the shape of the U.S. economy and stock market.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.