During third quarter 2018, the S&P 500 Index posted its biggest quarterly gain in nearly five years.
Tailwinds from strong corporate earnings and fiscal stimulus drove stocks higher.
Investors downplayed trade-related risks, anticipating limited effects on growth.
- Stock prices have just entered what is historically the best quarter of the year.
- Market volatility could increase as we near the November mid-term elections and an expected interest rate hike in December.
- Election outcomes are unlikely to materially change the investment landscape.
Data Source: FactSet
An update on U.S. trade agreements
Earlier this month, the U.S. inked a new trade agreement with Canada and Mexico. We believe the U.S. will eventually sign new trade agreements with the European Union and Japan, materially reducing the threat of a global trade war.
However, China remains the largest hurdle to improve the overall trade environment, and tensions with Beijing are likely to worsen next year. China’s approach to trade could become more isolated, as the rest of the world sympathizes with U.S. grievances against the alleged theft of intellectual property. In our view, tariffs on additional Chinese imports are a growing threat.
Can U.S. stocks continue their winning ways?
Trade tensions aside, the S&P 500 Index has notched positive returns over the last six consecutive months. Since 1928, there have been only five streaks when the Index was up each month April through September.
Historically, the S&P 500 has advanced 1.9% on average through the fourth quarter. Yet in periods when stocks have had a six-month run of gains through the end of September, as they did this year, the S&P 500 tacked on an additional 9.2% increase on average.1
Importantly, corporate earnings should continue to be a bright spot for investors through year-end as the U.S. economy continues to grow. However, rising interest rates are likely to create more headwinds for them in 2019.
Investors should look past the mid-term elections
Historically, market sentiment has been cautious leading into mid-term elections. Afterward, equity markets usually perform well for the six months that follow. We believe the most probable upcoming election results are unlikely to alter the political landscape enough to influence investment decisions.
With that said, the first two weeks of October have been very difficult for investors. Rising interest rates, concerns about the rate of earnings growth next year and trade tensions with China unexpectedly put investors on the defensive. Importantly, stocks may have been overdue for a pullback, but the positive economic backdrop could help buoy asset prices over time. However, long-term investors should stay the course, in our view.
Markets tend to trade sideways — in other words trading without forming a distinct trend — while heading into mid-term elections and then they tend to gravitate higher following the election. Although when the market anticipates a divided Congress, stocks usually gravitate higher up to and through the elections before drifting sideways further out from the elections, according to data from BCA Research.
In our view, investors are anticipating a divided government following the November election. The party controlling the legislature often loses its majority control during mid-term elections. We believe mid-term Congressional shifts, more than anything else, reflect the electorate’s desire for change as part of the ebb and flow of political power.
We also believe a divided Congress is unlikely to reverse the deregulation agenda from the White House, as regulatory affairs fall squarely under the President’s discretion. Importantly, if Democrats were to gain control of Congress, they are unlikely to assume the two-thirds majority in the Senate that would be needed to reverse the 2017 tax cuts.
In the past, divided governments have not stopped bull markets. If Republicans maintain control of Congress, we would expect more market-friendly initiatives such as tax cuts 2.0 and a material infrastructure spending bill.
Regardless of the mid-term election results next month, in our view trade and the direction of interest rates will likely exert greater influence on the stock market than politics. We also believe the overall, longer-term impact on stock prices is likely to be small.
That plays out historically: In the post-World War II era, the S&P 500 Index has posted gains in the 12 months following mid-term elections, according to FactSet. Considering the favorable U.S. economic backdrop and high consumer confidence levels, we believe equities could continue to hold that trend.
As always, talk with your Ameriprise financial advisor about your investment portfolio. Your advisor can equip you with information to understand your tolerance for risk, make informed decisions and take prudent steps to reach your goals.
As of October 12, 2018
Data source: Morningstar Direct