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Why the stock market will soon forget the midterm elections even happened

Joe Fahmy
Contributor
A woman places her ballot paper in the box during early voting for the mid-term elections in Sylmar, California on November 3, 2018. (Photo: Mark RalstonAFP/Getty Images)

The midterm elections will have no effect on the stock market this week. We might see a brief knee-jerk reaction if the unlikely scenario of the Democrats retaking both chambers of Congress occurs, but market participants need to be reminded that the main two drivers behind the stock market are earnings and interest rates.

The decline we saw in October was due to China trade war fears and the Federal Reserve’s steadfast adherence to raising interest rates. Many people feel the current correction is due to uncertainty over the upcoming elections. Proof that this is not the case will manifest itself after the elections are over. The markets will forget that the elections even occurred and continue to obsess over China and the Fed.

Politics are clearly polarizing in our society. The financial news outlets continuously talk about it because it stirs anger, creates fear, and increases ratings. Think about it. When do you turn on the Weather Channel? When a tornado, hurricane or blizzard is potentially approaching. No one watches when it’s 85 degrees and sunny outside. The same thing goes for financial television. The media loves to discuss politics because it heightens emotions and keeps people tuned in, but I am here to remind you that the outcome of the midterms is not important to the financial markets.

Six weeks before the U.S. Presidential Election in 2016, I wrote an article titled: The market is forecasting a Donald Trump victory. I specifically mentioned that it was not meant to be a political article, but rather an interpretation of the market’s technicals and the fundamental sectors that were looking strong. The same thing applies to this article. My job as a money manager is to interpret what I see and adjust client portfolios accordingly. It is highly unlikely that the extreme selling we saw in October had anything to do with the midterm elections.

The market is focused on bigger challenges ahead

The type of decline we experienced tells me the market is adjusting to the potential of an escalated trade war because tariffs could adversely affect earnings and lead to inflationary pressures. The other factor to consider is the market is a discounting mechanism. It trades on what is going to happen six to nine months from now. Besides the trade war, the market could also be adjusting to higher interest rates in the future. Currently, the Federal Reserve is planning to raise rates in December and forecasting three more hikes in 2019. The market is clearly telling us that it can’t handle these two forces right now and has to adjust to their potential unfavorable effects down the road.

Back to the midterms, the likely scenario according to most polls is the Republicans keep the Senate but lose the House. If this happens, we would have gridlock for the next two years and the market is perfectly fine with that because it survived well with eight years of gridlock before President Trump. If the Republicans maintain a majority in both the House and the Senate, the market will view this as a positive because Trump can continue with his pro-business agenda. There’s less than a 5% chance the Democrats retake both chambers of Congress. This could create a brief knee-jerk reaction, but again, the focus will quickly return to the bigger challenges at hand.

The main thing investors should be focusing on right now is that the market is in a correction and it is important to define one’s investment objectives. For example, investors should accept that we will have these types of corrections and stick to their longer-term discipline. Traders should remain defensive, especially with all the major market indexes below their 200-day moving averages. There’s nothing wrong with being cautious until we see healthier signs such as the major institutions consistently buying back into the market. Any resolution with the China trade war or dovish comments from the Fed would definitely be a positive for the markets. Until then, remember the wise words of Warren Buffett: “If you mix your politics with your investment decisions, you’re making a big mistake.”

Joe Fahmy is the managing director of Zor Capital.

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I can be reached at: jfahmy@zorcapital.com.

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