UBS head of wealth Naratil on election impact on markets

Members
of the U.S. House of Representatives are sworn in on the House
floor January 3, 2017.
Jonathan
Ernst/Reuters

• In this op-ed, UBS co-head of wealth and president of
  the Americas Tom Naratil discusses the investor
  implications of each potential outcome for the midterm
  elections.
• Trade will remain the most powerful economic issue
  regardless of who controls Congress, Naratil
  writes. 

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Investors are likely to find
themselves tired of rhetoric, short on patience and disappointed
with the consistent flood of commentary on the mid-term
Congressional elections this fall. However, as many have learned
since the fall of 2016, with the longest-ever bull market
approaching 3,500 days, investing based on personal reactions to
electoral results often leads to suboptimal results. Further,
research has shown that political bias can significantly hamper
investors’ ability to make prudent investment decisions –
especially if they allow political disappointment to morph into
investment pessimism or fear.

Now, roughly two months from
Election Day, it’s a good time to consider how the composition of
the 116th Congress may impact investors’ decision-making. Here
are four potential electoral outcomes and what they could mean
for markets (note that these scenarios should not be interpreted
as support for any political party or candidate).

First, a “red tide,” in which
Republicans expand their majority. While this outcome is
improbable in our view, it would likely be supportive for risk
assets. Substantial Republican gains would also set the stage for
party leaders to address deficit concerns through major
initiatives like entitlement reform, which would support stocks,
the US dollar and US Treasuries. Conventional wisdom, however, is
that Republicans will probably lose at least a few seats.

 
A second but still unlikely outcome is the
“status quo”: Republicans keep a reduced majority in both
chambers of Congress. This result would likely support stocks in
the short term but hinder attempts to address the deficit,
putting downward pressure on US Treasuries and the US
dollar.

 
Third, and far more likely in our view, is
the “historical norm”: the non-incumbent party – in this case the
Democrats – picks up a modest majority in the House, while
Republicans hold onto the Senate. Should this happen, expect
legislative gridlock to put renewed pressure on the dollar and
Treasuries.

Probably the biggest red herring
for investors in this outcome is the possibility that a
Democrat-controlled House impeaches President Trump. It’s
important to acknowledge that unless a Republican Senate voted to
remove the President – unlikely, in our view – there would still
be few immediate implications for US policy and hence for markets
(which didn’t blink after the House impeached President Clinton
in 1998).

What happens in a fourth scenario
in which Democrats gain sizable control of the House and a
majority in the Senate? A so-called “blue wave” is much less
likely than the “historical norm,” though worth considering as it
may carry the most uncertainty for investors. In this scenario we
expect DC gridlock to worsen and more last-minute dealmaking over
issues like the debt ceiling. During the debt ceiling crisis in
2011, the S&P 500 dropped nearly 20% in just a few weeks.
Market shocks like this become more possible when extreme
gridlock prevents policymakers from acting swiftly and
decisively.

Today, the investors I speak with
are most concerned with the impact of global trading policies on
the economy and markets, and want to know what impact midterm
changes could have. In fact, in UBS’s most recent Investor Watch
Pulse survey of US business owners and investors, most had very
strong views on the topic and favored fighting back against
unfair trade practices, even if they find a full-blown trade war
unpalatable.

 
They’re right to be concerned about the
potential effects of a trade war on market stability and growth,
but when it comes to questioning how any potential mid-term
changes could impact the simmering dispute, the short answer is
not much. Trade will remain the most powerful economic issue
regardless of who controls Congress, since President Trump’s
policies will continue to be the most important variable. In
other words, investors should keep a close eye on where trade is
heading, but shouldn’t expect the mid-terms to heavily sway the
debate.

 
With mid-term fever inevitably set to descend
on the country, wealth managers and financial advisors must help
investors cut through the noise, prepare them for any resulting
volatility, and keep them focused on their longer-term goals.
Emotional decision-making rarely leads to optimal outcomes.
Instead, advisors must encourage investors to stay the course
with their financial plans and to tactically take advantage of
excessive market reactions.

Goals-oriented investors with a
financial plan and a prudent financial advisor will know what to
listen to, what to disregard and how to react when the election
results come in.

– Tom Naratil is co-president
of UBS Global Wealth Management and president of UBS
Americas