Street Vision: A Wave of Optimism

For at least a year leading into the Midterm Elections we heard from multiple media pundits and political prognosticators about the tsunami-like Blue Wave that would bring a titanic shift of power to the Democrat side of the isle in both houses of U.S. Congress.

While the final result was a split decision, we’ve seen numerous mentions of the Green Wave that actually took place.

The Green Wave metaphor is a play on words used by some to highlight the historic amount of money spent in the U.S. House and Senatorial elections, and by others bringing attention to at least a half a half dozen State referendums legalizing marijuana that range from medical use to recreational decriminalization.

The resignation of Jeff Sessions as Attorney General, an ardent opponent of legalization, has fueled speculation that some relaxation of marijuana laws at the national level is likely in the offing before the 2020 Presidential Election cycle kicks into gear.

The Real Wave

In reality, the most convincing we saw this week was the massive Wave of Optimism that washed upon the financial markets following the election results.

Investors wasted no time Wednesday in stamping their approval on the election results as stocks started the day with close to a +1% gap and climbed steadily higher throughout the day. Major Market averages finished the session with gains ranging from +2.15% on the Dow Jones Industrial Average (^DJI) and S&P 500 (^SPX), to +2.65% on the NASDAQ Composite (^IXIC).

For a historical perspective, stocks had their single best day of trading following a midterm election since 1982. Let’s see, who has in their first term as President in 1982?

That’s right. Ronald Reagan. What an amazing historical parallel.

The rally was broad based Wednesday, as both the technology and transportation sectors, laggards of late, joined in. Volumes were brisk, and market breadth was solid with advancing issues beating decliners by better than 3 to 1 on the NYSE and better that 2 to 1 in the NASDAQ market.

On Thursday, stocks held nearly all of their gains, shrugging off a round of selling mid afternoon, following the Federal Reserve policy statement reiterating the strength of the economy, and the likelihood of 2 to 3 more interest rate hikes looking out to June 2019. It’s worth noting that bonds were weak, with the 10 year treasury yield closing just above 3.2%.

Why the Optimism?

The obvious question is, and I got it at least a dozen times mid week, is Why the big rally in stocks with the Republicans losing the House? I think there is really a 2 pronged answer:

First, markets were set up for a post election relief rally, almost regardless of the outcome. Most professional investors would like to minimize the political “noise” as much as possible, focusing on the macro economy and prospects for earnings and revenue growth for companies they follow and/or own. Also, markets had “priced in” Republicans holding the Senate while likely losing the House as the most likely outcome of the midterm elections.

Second, away from overly simplistic market axioms that “gridlock is good”, it is still under appreciated by many, the positive effect from structural reforms enacted by the Trump Administration over the last 20 months:

Regulatory reform,

Significantly lower corporate taxes,

Repatriation of corporate cash overseas,

Individual tax reform,

Reworking of outdated Trade Agreements

These are five major accomplishments in less than 2 years that are contributing to a rate of economic growth previously thought to be unattainable. Most importantly, none of these structural reforms can be overturned by a Democrat held House while President Trump has an expanded majority in the Senate.

Even if a Democratic House prevents the Trump administration from advancing additional pro growth legislation, just going on cruise control the next 2 years with the positive initiatives already in place will likely produce economic growth at a rate above the consensus view.

Make no mistake, the stock market will not be without hiccups and hurdles.

Getting accustomed to gradually higher rates immediately comes to mind. Conversely if GDP continues to grow at a rate higher than base interest rates and inflation, and if Corporate profits can adjust to rates of YoY growth in the mid teens, Financial markets, albeit with a few adjustments along the way will embrace it.