It’s not surprising that Wall Street likes political policies and programs that stimulate business and investment. But there’s not always a correlation between major events, like the passage of the Tax Cuts and Jobs Act of 2017, and an upturn in the U.S. stock market.
In 2017, the Dow Jones Industrial Average rose about 25 percent as many investors anticipated the tax reform package would clear Congress and be signed into law. But in the 11 months since then, the Dow fluctuated dramatically and was only up about 5 percent as of early November.
So, what does this indicate to the midterm election and your investment portfolio? It means that Wall Street was expecting the Democrats to take control of the House and Republicans to maintain control of the Senate. Because there were no surprises in the outcome, there was little change in the Dow or other stock market indexes related to the election.
Now, financial analysts and investors are looking ahead to the next two years, looking at the trends and risk factors that could impact U.S. stocks and bonds. First of all, the political split in Congress means there is little likelihood of a significant change in the current business climate. For instance, the Affordable Care Act (ACA) most likely will continue for the next two years, providing some measure of stability for the nation’s healthcare and insurance companies.
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Historically, the year following a midterm election has seen positive returns in the stock market. However, there are no guarantees when it comes to the financial markets. Instead, investors will be trying to focus on a variety of potential risks, both in the U.S. and abroad.
For example, higher U.S. tariffs on imported goods from China and other countries could raise prices and impact the sales of manufacturing, distribution and retail companies. Trade wars would also affect the nation’s agricultural companies as exporting U.S. goods becomes more difficult.
Another issue facing investors is whether the Federal Reserve will continue its interest rate hikes, and what that might say about the health of the economy. Historically, the bond market responds well to rate increases, but the stock market does not. That’s one good reason for maintaining a diversified portfolio that includes stocks and bonds, and possibly alternative assets like real estate which are not highly correlated with the financial market.
Wall Street analysts also pay close attention to corporate earnings. When companies report higher profits, their stock prices typically go up and go down when the companies' profits decline . At this point, it appears that corporate earnings have leveled off at a high plateau, raising the possibility of a decline in 2019. Of course, every company has a different earnings profile, so investors should do their homework and look at both past performance and potential growth before making a decision.
Even though Wall Street shrugged off the midterm results, there are still plenty of concerns about the U.S. hyper-partisan political climate and what that means for the three branches of the federal government. Globally, there are worries about rising tensions with the nation’s European allies, as well as Russia, Iran and Korea.
With the end of 2018 approaching, now is an excellent time for investors to take a careful look their portfolios and discuss these risk factors with their financial advisors. While there may be tactical opportunities to boost returns in the stock and bond markets, a cautious approach should be considered in today’s volatile world.
Andrew Menachem, CIMA®, is a Wealth Adviser at The Menachem Group at Morgan Stanley in Aventura. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors. Follow Menachem on Twitter @AMenachemMS