Policy Shifts, Not Valuation, to Drive US Equities After Mid-Terms

Future returns in US equities will hinge on policy choices rather than shifts in market valuation following Democratic gains in the mid-term elections, according to Steven Blitz, managing director of global macro and strategy and chief US economist at GlobalData.TSLombard.

"Rerating is not the equity market's major problem going forward, policies are," Blitz wrote.

The new Congress will act as a check on the administration without necessarily controlling its broader agenda, he noted.

Decisions from the administration and the Federal Reserve, along with geopolitical developments, will carry more weight than the election outcome itself, Blitz argued.

Historical data shows the party winning mid-term elections does not dictate equity market direction. In four of the six mid-terms since 2002, markets continued moving in the same direction they had been heading before the vote.

In 2018, the market dropped 9% from election day through year-end. Blitz attributed that decline to Federal Reserve tightening, not to Democrats picking up 41 House seats.

The market also fell 3.9% from election day to year-end in 2002, even though the Bush administration added eight House seats and two Senate seats.

Volatility around mid-terms has shown no clear trend. The VIX averaged 21.9 before elections and 19.5 afterwards — a difference Blitz called "a statistical difference with no meaning".

The market appears fairly priced when measured against bonds and the nominal economy, Blitz said.

The S&P 500 trades at a forward price-to-earnings ratio of 21, yielding an earnings rate of 4.78%. At that pace, prices would double in 15 years.

Average annual nominal economic growth ran at 5.7% over the past decade, a rate that would double GDP in 13 years. A 10-year zero-coupon bond yield of 4.9% implies capital would double in 14 years.

"The 10Y is not yet cheap enough to pull money from stocks," Blitz wrote. Sector indices are similarly priced, though valuation gaps are wider among the 20 largest companies by market capitalisation.

"The equity market is fairly valued," Blitz concluded.