A word for Wall Street and Main Street: Caution

By Ron Insana, CNBC Senior Analyst and MB Contributor

Impact of the midterm elections

The views and opinions expressed in this article are solely those of the author and do not represent the views of MB Financial, its Board of Directors, employees or shareholders.

Those who thought a change in the composition of Congress would lead to a market sell-off turned out to be wrong. Stocks have come to terms with the divided government that will dominate Washington, D.C. until the next presidential election and with the stock market posting solid gains in the days after the midterms, it appears that investors see more positives than negatives on the immediate horizon.

As Democrats take control of the committees in the House of Representatives, we can expect a more combative environment: one that opens, or in some cases reopens, investigations into the president’s conduct, both in the political and business arenas. We’ve already heard from some incoming committee chairs that deeper explorations into alleged ties to Russia, the presidential tax returns and other business dealings could be on the docket in the months ahead.

In addition, it seems plausible to expect in now-closed House intelligence investigations that subpoenas for those witnesses who were never called when Republicans controlled the process may be issued.  Having said that, it appears Wall Street views that process as a distraction rather than outright destruction of this administration. 

Indeed, rather than riding the crest of a “blue wave,” some Democratic strategists have conceded that the result of the midterm elections is more of a rebound rather than a complete resurrection of Democratic ideals. With Republicans gaining seats in the Senate, recapturing the House was less of a complete repudiation of the president versus a realignment of the political map, with suburban women, people of color and college-educated citizens turning out to install Democrats in already “blue” areas that were lost to “red” voters in 2016.

From an investment perspective, the markets are getting a boost from the notion that instead of complete gridlock in the nation’s capital, there could be some bipartisan progress on infrastructure investment, a high priority for both Democrats and the president. Senate Majority Leader Mitch McConnell suggested that an infrastructure bill was a distinct near-term possibility, giving Wall Street a theme to exploit in the immediate aftermath of the election. Under those circumstances, industrial and infrastructure stocks, along with municipal bonds, may be near-term beneficiaries of that common ground. 

While there are risks that a clash between the House and White House could emerge as Democrats demand more accountability and more transparency from this administration, the stock market’s post-election rally suggests that, at least for now, that is a misplaced concern. The uncertainty surrounding the election results is now out of the way. The economy remains strong and third-quarter profits have risen roughly 27% among reports delivered thus far, outpacing the gains in both the first and second quarters of 2018. 

The risks, then, essentially, haven’t changed. The Federal Reserve is on track to raise interest rates in December and maybe another three times in 2019. Corporate profits may be peaking, even as I write, setting the stage for consolidation in the year ahead. The White House, without election considerations ahead, could engage China in a full-scale trade war, arguing that in the long run, the U.S. will win, even if both Wall Street and Main Street may lose in the short run. And, of course, the immigration debate could intensify as U.S. businesses struggle to find low-skilled to highly skilled workers in an increasingly tight labor market, something that could push inflation higher and force the Fed to act faster to fight it.

The post-election gains could simply represent a relief rally on Wall Street, with one variable now a known quantity. I have argued that Wall Street might, in fact, see the so-called “presidential cycle” work in reverse. Where new presidents typically take economic pain up front and stimulate the economy as re-election rears its head, this president stimulated a growing economy, front-loading gains he might have used to bolster his chances in 2020.

In typical presidential cycles, the third year of a president’s term is often the strongest while the fourth year comes in second. Given a divided government, a fiscal stimulus already spent and a Fed that is raising rates, the post-election environment may be less hospitable than in prior periods. Caution may be a watchword for Wall Street, and Main Street investors, going forward.