iShares Investment Strategy

US midterm election result

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Any opinions or forecasts represent an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results.

Key points:

  • A divided Congress means policy stasis and has historically tended to benefit equities
  • The US remains our preferred region for developed market equity exposure
  • Although we maintain a positive outlook for US equities, portfolio resilience is key

We see the result of the US midterm elections – with the Democrats taking control of the House of Representatives and the Republican Party retaining the Senate – having few market implications for now. There is a low risk of rollbacks to the administration’s tax cuts and regulatory policies in the short term.

A divided Congress means policy stasis and has historically tended to benefit equities, but we see potential disruptors: US-China tensions, given bipartisan support for cracking down on China’s trade and intellectual property practices; and increasing partisan confrontation as the Democrats have vowed to use their oversight powers.

A divided Congress means policy stasis and has historically tended to benefit equities, but we see potential disruptors: US-China tensions, given bipartisan support for cracking down on China’s trade and intellectual property practices; and increasing partisan confrontation as the Democrats have vowed to use their oversight powers.

Back to fundamentals: positive on
US equities

Looking beyond the election result, the US remains our preferred region for developed market equity exposure. The underlying fundamentals are still favourable:

  1. The US economy is powering on. Recent data adds further evidence of a strong US expansion, with annualised GDP growth reaching 3.5% in Q3*. The non-farm payroll release for October beat market expectations, with c.250k jobs added*. This is just one of a number of indicators that have surpassed market expectations this year.
  2. US earnings growth continues (c.27% growth in S&P500 earnings in Q3 2018 compared to Q3 2017*), despite continuing trade tensions.

We see the US economy in a late-cycle expansionary stage and favour the financials sector and momentum exposures, especially technology. Technology stocks traditionally hold high levels of cash on their balance sheets, which means they could be well positioned in an environment of increased volatility. Strong earnings growth also underpins our preference for the sector. We believe financial stocks – especially US banks – are poised to benefit from the rate rise cycle.

*Source: Bloomberg, as at 7 November 2018.

Investing amid a rate rise cycle

Strong US growth is helping to keep the Federal Reserve (Fed) on a path of tightening, with markets pricing in one more US rate hike in 2018 and roughly two in 2019. In this context, we see value in floating-rate notes where income moves up with interest rates. Floating-rate notes also act as a hedge against the tail-risk of a stimulusdriven overheating of the US economy, which could prompt the Fed to raise short-term rates more quickly than markets currently anticipate.

Resilience is key

Although we maintain a positive outlook for US equities, portfolio resilience is becoming increasingly important, as recent market volatility has shown. For defence, we prefer the quality factor, encompassing firms with solid balance sheets, high return on equity and other strong fundamentals. At this stage in the cycle, we see quality factor stocks offering better ballast than traditional bond-proxy stocks, which may not provide the safety that investors have come to expect. See our report – Building the right defence in equities – for more details. US Treasuries are another diversifier, and we prefer the front end of the curve. In our view, higher yields favour short over long maturities in government debt as they now offer positive real yields after inflation, with more of a cushion to protect against rising rates than in the recent past.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.