Market Headwinds: Politics and Trade at the Core
Midterm Elections Create Uncertainty
As summer turns to fall, stock markets are encountering greater turbulence. This is not unusual for a midterm election year, as voters rebuke the incumbent party for policy shifts implemented during the early stages of an administration. The resulting uncertainty about future policy typically leads to a more volatile environment for capital markets. If history is any guide, however, stocks could rally strongly after Election Day regardless of who wins the midterms.
This historical precedent may be especially important this year. Stock markets have taken their cues from the aggressively pro-growth economic policies implemented by the Trump Administration, but gains of late have been buffeted by an escalation of a global trade war with a clear focus on pressuring China to implement structural reforms. Most polls are predicting a gridlocked Congress following the elections, though the last two months of the year could be poised for major stock market moves to the upside if the Republican Party is able to sweep, retain its majority, and double down on its agenda.
Outside of a noticeable slowing in the interest-rate-sensitive housing and automobile markets, the U.S. economy is booming, with the underlying trend pointing to GDP growth of 3% or more. Since most measures of inflation are closer to the Federal Reserve’s target of 2%, the economy is now expanding by north of 5% in nominal terms, creating jobs at a rate which has pushed unemployment down to 3.7% (its lowest level since December 1969). As President Clinton famously quipped regarding the single most important driver of election outcomes: “It’s the economy, stupid!”
It’s no wonder President Trump is trying to jawbone the Federal Reserve (Fed) into not taking away the punchbowl too quickly. He has voiced his displeasure at the Fed’s commitment to increasing interest rates and reducing its balance sheet to normalize monetary policy. Jay Powell, the first Fed chairman since Paul Volcker who is not an academically trained economist, has not budged, reinforcing the Fed’s independence from political pressure. He seems more skeptical about the Fed’s ability to fine-tune the economy using precise economic modeling. Paul Volcker’s tenure ultimately ushered in a thirty-year decline in interest rates to roundly defeat the forces of inflation. Perhaps Jay Powell’s tenure will be remembered as the beginning of a secular rise in interest rates as inflation reemerges.
Are the Terms of Trade Changing?
For decades, China has charged a much-higher tariff on imports than the U.S. or European Union, often violating World Trade Organization rules. China is also alleged to be systematically stealing intellectual property from international technology companies with which it conducts business. The integrated cross-border supply chains which support global manufacturing today often run through China. Thus, they are likely to feel the most pressure from tariffs at a time when China’s economy has already shown a noticeable slowdown in economic growth. Chinese stock markets, as well as those in the rest of the emerging world, have remained under sharp pressure as a result. Markets are now increasingly concerned about the 2018 global trade war potentially devolving into a more protracted and broader economic and geopolitical “cold war” with China—leading to a reversal in the disinflationary forces globalization spurred over the last several decades. So far, there is little cause for concern about the U.S. economy since the stimulus from fiscal policy still dwarfs the obstacles to growth from tariff increases to date.
 According to data analyzed by Strategas, since 1962, the average stock market correction for midterm election years is around 19%. However, stocks have ended the following year higher every time by an average of 31%. In fact, the S&P 500 has not declined in the year following a midterm election since 1938.
 As if polls are still credible after their stunningly incorrect predictions about “Brexit” and the 2016 U.S. presidential election!
 The quarter containing the midterm election and the quarter immediately thereafter are historically the strongest two quarters of the presidential cycle, regardless of the results of the midterm election—and this contemplates a typical weak start to the midterm quarter ahead of the election.
 Strategas estimates the positive incremental effect from fiscal policy to add around $1 trillion to U.S. GDP from tax cuts, spending increases, and repatriated corporate profits. That far surpasses the negative effects of around $133 billion – $213 billion from the three rounds of tariff increases that have been announced so far.
The views expressed represent the opinion of Balentine. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Balentine believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Balentine’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.
Balentine utilizes proprietary models to evaluate economic trends. The Tier 1 model gives us parameters to determine how we should allocate our assets across our building blocks. The Tier 2 model guides us toward allocating within building blocks. Balentine uses a combination of several factors, of which models are only part, when determining its investment outlook. Balentine is not soliciting or recommending any action based on any information in this document.
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