The big surprise from the US midterm election was that there was no surprise! Unlike with Brexit and Trump’s election in 2016, the polls and betting markets were spot on! So why did shares rally in response?

There are basically three reasons.

First, while the Democrats now control the House it wasn’t the “blue wave” some had talked about as the Grand Old Party also increased its Senate majority, which means that while another round of tax cuts is unlikely (which may be a good thing as it would only mean more pressure on US interest rates), the Democrats won’t be able to wind back Trump’s first round of tax cuts and won’t be able to reregulate the US economy either. Similarly, while the Democrats will likely harass Trump with investigative committees and maybe even impeachment proceedings, they won’t get the 67 Senate votes necessary to remove him from office. (Unless of course Mueller or others can show he has done something really bad – mind you, Trump’s decision to sack Attorney General Jeff Sessions doesn’t inspire a lot of confidence on this front!).

Second, just getting the midterms out of the way provides relief.

And third, US shares have rallied over the 12 months after each midterm since 1946, as the president refocuses on his own re-election. Trump is likely to do the same, which means doing nothing to weaken the economy and fix the trade war with China some time in the next six months. 

However, it’s not going to be smoothing sailing. Key events on the US political front to watch out for in the next few months include:

• headlines around the Mueller inquiry;

• the Trump/Xi meeting later this month at the G20 summit;

• the need for another “continuing government funding resolution” to avoid another US government shutdown from December 7 (this could create a bit of noise given Trump’s past threats to shut down the government if he doesn’t get funding for his wall) but ultimately an extended shutdown in the run up to Christmas is in neither sides interest;

• the need to increase the debt limit sometime after March 1 next year – where the Democrats could try and force Trump to lift the corporate tax rate in return for raising the debt ceiling.

In terms of the US/China trade conflict, while Chinese President Xi Jinping in a speech in the last week made veiled criticism of Trump’s protectionism, he also indicated ongoing tariff cuts on imports and a tightening in protection for intellectual property, with China’s Vice Premier Wang indicating that China remains ready for negotiation on the trade issue. There is a long way to go here but I remain of the view that a deal will be made with China before the tariffs are allowed to cause too much damage to the US economy. 

On the property and interest rate front

National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Our assessment is that the RBA is underestimating the threat posed by slowing growth in China, tightening credit conditions and a negative wealth effect, as house prices continue to fall. As a result, in contrast to the RBA, we see growth slowing to around 2.5-3% through 2019, which in turn will result in higher unemployment and keep wages growth and inflation lower for longer than the RBA is allowing. So we remain of the view that a rate hike is unlikely until late 2020 at the earliest and that a rate cut later next year can’t be ruled out. Out of interest its doubtful that even the RBA’s more optimistic 2019 forecasts would justify a rate hike next year as they only see wages growth getting up to a still anaemic 2.5% year-on-year and inflation rising to just 2.25%.