Investors need to cut through the noise around the US midterm elections and focus on the long-term fundamentals, says AJ Bell.
With the Democrats seizing control of the House of Representatives and the Senate in a double blow to President Trump, AJ Bell said investors will be scrutinising how changing control could impact economic policy, particularly with the elections taking place against an unusually divisive backdrop of geopolitical strain.
James Flintoft, head of investment solutions at AJ Bell, said: “A shift in the balance of power may at first appear to affect the tone of foreign policy and have potential implications for markets. Yet there remains a large gap between recognising that US politics matters and making investment decisions based on midterm forecasts, with the pitfall of trying to time markets.
“Making investment choices based on the midterms is inherently difficult as investors must also anticipate which policies can become law and how markets will respond. Even a correct forecast of the result is not enough if markets respond to something else.”
Flintoft said markets continually absorb election news, so a widely expected result should already be partly reflected in prices.
Furthermore, political pushback against an incumbent administration is a familiar feature of the midterm cycle, with attention then returning to the key themes impacting markets, including inflation, interest rates and corporate earnings.
Flintoft continued: “For long-term investors, these fundamentals usually carry more weight than the midterm result itself. A new congressional balance may influence some of these factors, particularly fiscal policy, regulation and foreign policy, but it rarely controls all of them. The result may also see the President turning back to executive orders regarding foreign policy.
“In the long term, the direction of US equities is not simply determined by the outcome of the midterms. Many of the largest US companies earn revenues worldwide, leaving their prospects dependent on global business conditions as well as domestic policy.”
Flintoft warned that investors who reduce exposure while waiting for political clarity also face another issue; prices can recover before the outlook feels comfortable and several of the strongest days often occur close to periods of heightened uncertainty.
Selling and later reinvesting therefore requires two well-timed decisions. The cost of being out of the market often exceeds the damage caused by the event investors were trying to avoid, he notes.
“Diversification remains the more reliable response. Holding a range of asset classes, regions, sectors and return drivers reduces dependence on one political result or economic scenario. It accepts that uncertainty cannot be eliminated and makes the portfolio less reliant on forecasts that may be wrong.
“The US midterms matter to the people, policymakers and individual companies exposed to specific policy areas, and could carry wider implications for the direction of US foreign policy. Even so, investors are generally better served by concentrating on valuations, fundamentals and diversification than by trying to predict the composition of Congress and second-guess the market reaction at the same time. These events can create shorter-term noise in markets, but as ever we will be concentrating on what the longer-term implications are for portfolios,” Flintoft added.
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