Australian shares are set to open the week slightly lower ahead of the 2018 US midterm elections on Tuesday, with analysts saying the Democrats’ expected victory in the House of Representatives has largely been priced into local markets.

On Sunday, ASX futures were down 5 points or just under 0.1 per cent, indicating the local market would open the week lower after US stocks closed Friday’s trading in the red.

Concerns a trade deal with China was further away than first thought saw the S&P 500 close 0.6 per cent lower, despite the index opening the session higher on the back of positive non-farm payroll data.

The S&P 500 ended last week up 1 per cent, but Australian shares held up much better, ending last week 3.2 per cent higher.   

Christopher Cuesta says markets have already priced in Democrats winning the House.
Christopher Cuesta says markets have already priced in Democrats winning the House.

Christopher Pearce

While trade concerns will be front of mind for Australian investors at the start of the week, attention will quickly turn to the US midterms, with the result of the elections set to be released during local trading on Wednesday.

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All 435 seats in the US House of Representatives and 35 of the 100 seats in the Senate will be contested on Tuesday US time, with the most likely result being the Republicans retain control of the Senate and Democrats take control of the House.

Likely outcomes

While Australia will be one of the first markets to react to the result, analysts said it’s unlikely to move markets to a great degree with the most probable result already priced in.

“The US midterms will have some impact on the markets, but I believe the base case which is expected will not move markets to a great degree,” said THB Asset Management chief executive Christopher Cuesta. “Right now Republicans control the executive branch, the House and Senate. Most polls suggest the Democrats will regain control of the House, but not the Senate.

“Under that scenario there will be a divided Congress that would leave the direction of existing policy unchanged, with no major changes to tax, spending or trade policies. There will be minimal impact to the economy or growth rates so there should be no impact on the stocks. A remote possibility under this scenario could be bipartisan support for an infrastructure bill, which would be viewed favourably by the market.”

Mr Cuesta said his next most likely outcome, that Republicans maintain control of both houses, would be the most favourable for equities.

“Scenario two would see the Republicans maintain their existing control and would likely cause an expansion of the tax cuts and fiscal stimulus policies already in place,” he said. “This is the most ‘risk on’ outcome and likely to cause a sharp market move as it appears the market is pricing in the first scenario.”

Democratic victory

Mr Cuesta said markets would react negatively were the Democrats to take control of both houses. “This would bring increased probability of rising regulation, renewed single-payer healthcare policies and possibly higher minimum wages,” he said. “This would be negative for equities and the US dollar. Rates will likely fall too.”

Donald Trump has already touted what a Democrat victory would do the markets, tweeting on Tuesday: “If you want your Stocks to go down, I strongly suggest voting Democrat.”

Morphic Asset Management head of macro and risk Geoff Wood said a Democratic victory in both houses would likely result in President Trump ramping up trade tensions, something that could pose a risk to Australia.

“If the Democrats manage to win both, it doesn’t leave Trump with much power,” he said. “It only leaves him with the tariffs and he might end up driving the tariff debate with China even harder. He likes headlines and the only thing he can lever with is tariffs.

“You could probably see things like the renminbi and Aussie dollar selling off. Ultimately, if the Democrats win and there’s more tariffs, that wouldn’t be good for the Chinese growth.”

Post-election volatility

Mr Wood said that investors had to be flexible, with Mr Trump’s election and Brexit showing just how volatile the market can be following a surprise result.

“The one thing to come out of the results in the last few years, is it isn’t always obvious how the market will react,” he said. “It’s one thing to have a game plan but you have to be able adjust.”

Societe Generale economists Stephen Gallagher and Omair Sharif said last week that there would be a post-election bounce on the market, regardless of the result.

“We do not see the upcoming election as an immediate trigger of the recent bouts of financial market volatility,” they said. “Nevertheless, since our August midterm report, the pullback increases the likelihood of a post-election bounce. This view is not predicated on any particular election outcome. It is a view that reflects new potential due to recent activity and the conclusion of the elections without any material disturbance.”

The pair also noted that a Democratic majority in the House could be a reason for the FOMC to turn cautious, as a divided congress made the probability of a government shutdown more likely.

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