US midterms - a decisive win for the Democrats. What now?

The US midterm results have reshaped the balance of power in Washington, with the Democrats taking control of both the House and the Senate. But what does a Democrat-controlled Congress mean for investors? The implications could be significant for President Trump's policy agenda.

Yet while political developments can grab investor attention and impact market sentiment, how much do they affect the return and risks of assets over the longer term? Read our latest analysis on these election results and why economic fundamentals and valuations may matter more than today's headlines. 

At a glance

• Democrat control of Congress weakens President Trump’s ability to advance major policy changes without cross-party cooperation.
• This raises the possibility of greater political confrontation with the administration. Yet, it could also present a clearer framework for assessing the likelihood of changes to taxation, regulation and government spending.
• It may allow investors to focus more on fundamentals such as economic growth, inflation, interest rates, earnings and valuations.

In the event, the polls leading up to the midterms greatly underestimated the swing to the Democrats. They have gained control of both the House of Representatives (the House) and the Senate. This gives the party full control of Congress for the remaining two years of President Donald Trump’s term. Given Trump’s record low approval ratings for a second-term president and voter concerns over issues including the economy, foreign policy and immigration, the results should probably come as little surprise.

At first glance, a Democratic clean sweep may appear unsettling for financial markets, raising the prospect of a more active legislative agenda and greater scrutiny of the White House. However, investors are often more concerned by political uncertainty than by the disagreement itself. The election is now settled and the balance of power established for the remainder of this administration.

US midterms – what next for Trump and markets?

Midterm elections are usually tough for a sitting president, whether Republican or Democrat. Both Trump and Joe Biden lost control of the House during their midterms in 2018 and 2022 respectively.

For the remainder of his presidency, Trump will be in a weaker position. While he retains the power to veto legislation, any attempt by Congress to override this will need a two-thirds majority in both the Senate and the House. Trump will have to negotiate with the Democratic leaders in both chambers to pass major legislation, particularly on federal government spending and tax policy. Democrats are also expected to increase scrutiny of the administration. This includes holding hearings, issuing subpoenas and document requests.

Businesses and investors now have a clearer framework for assessing the likelihood of changes to taxation, regulation and government spending. As a result, markets may increasingly focus on economic fundamentals such as economic growth, corporate earnings and valuations, as well as inflation and interest rates.

Anthony McDonald, a multi-asset portfolio manager at SJP adds: “while the Republican Party has lost control of Congress, the impact on the markets may be limited as economic policy uncertainty is already high”.

Some fixed income investors believe that Democratic control of Congress may encourage greater fiscal discipline in areas of government spending. According to Greg Venizelos, SJP’s Fixed Income Strategist, “this could help contain upward pressure on US Treasury yields”.  

Yet it won’t be plain sailing. Hetal Mehta, SJP’s Chief Economist adds “US fiscal deficits of 6-7% of gross domestic product are likely to persist. Moreover, President Trump can continue to use executive orders when it comes to foreign policy, leaving geopolitical risks elevated”.

The chart below shows that in the 12-month period following recent midterm elections, the benchmark S&P 500 stock market has averaged double-digit percentage returns. This was irrespective of whichever party was in control of Congress. However, despite the strength of this historic track record, this is no guarantee of future returns. It is the outlook for the economy, inflation, interest rates and corporate earnings that will be more significant for future returns.