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What impact the midterms for UK investors?

8 November 2018

With the Rathbones multi-asset portfolio heavily invested in the US, funds manager David Coombs looks at the possible impact of the US mid-term elections on the US economy and stockmarket performance.

As far back as the 1950s, midterms have had a pretty benign effect on American stock markets.

While, fewer than 15 elections doesn’t provide enough data to be firmly confident, US stocks have tended to be rather directionless in the six months leading up to the vote with a bit of extra volatility (much like this year).

Then, the S&P 500 typically rose steadily in the following six months. And the election results didn’t really matter one bit.

Of course, the past is no forecast of the future. But we think Wednesday’s result shouldn’t have too much impact on equities.

The Democrats took control of the House of Representatives, as expected and in line with history (Republican Presidents tend to lose about 7% of House seats in midterm elections). But the Republicans strengthened their hold in the Senate.

The main consequence of losing control of the House means President Donald Trump’s fiscal agenda will be hamstrung. Still, he has already played his big fiscal hands. Besides, more than a few Democrats campaigned and won their seats on centrist platforms, pledging infrastructure spending and a more co-operative relationship with the President and Republicans. If both sides want better infrastructure, there could be an outside chance of a deal in the next couple of years.

Unless futile House Democrat impeachment proceedings swamp bipartisan feelings in vitriol.

What’s important?

For us as investors, however, we believe the midterms – or the altered political environment they’ve ushered in – aren’t really that important.

Our funds invest heavily in the US, but that’s not because of tax cuts, the prospect of an infrastructure splurge or even deregulation. We buy American companies, in the main, because we feel they are the best in the world. There is no European Google, no Japanese Amazon, no UK Visa. We aim to buy businesses that are unique, that offer something that other companies can’t, whether through size, service or superior technology. They tend to have low levels of debt and make high returns relative to the assets they use to operate, like buildings, trucks, servers or factories. We believe that should make them more resilient in a downturn.

Sales for these sorts of companies tend to be less tied to economic growth. For instance, Visa benefits from people increasingly ditching cash for electronic payments. This is unlikely to reverse because of lower global GDP growth.

Similarly, Amazon is growing rapidly, but most of that is due to it taking other retailers’ market share as opposed to the speed of expansion in Western economies. The US grew 2.9% over the past year; Amazon’s revenue increased 10 times as much.

Unfortunately, companies like the ones we describe don’t come cheap. This heightens the risk that their prices could fall sharply over shorter periods if investors take fright. We saw this in early October when technology companies led the wider market lower, and then lower again. We believe these businesses are the ones to own, especially compared with others that seem more susceptible to competition or from rising borrowing costs making their debts unmanageable.

So we are happy to take opportunities to buy when they fall, but we ensure we hold other, more defensive assets, including a spread of foreign currency government bonds and commodities like gold, to offset the potential for setbacks in stock markets.

This isn’t fool proof – we can’t foretell the future anymore than others can. But we believe owning the best companies, the ones that offer what others can’t, is the best strategy. We try to ensure we don’t overpay, selling small proportions of our shareholdings when prices look high and buying them back when it they dip. But buying struggling companies because they are very cheap doesn’t make sense to us.

In the end, it comes down which businesses we think will still be here in a decade. A reshuffle in Congress isn’t going to change our opinions.

 

 

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