October was a rough month for the stock market, proven by the decline of the NASDAQ and Dow Jones Industrial Average into clear correction territory, while the S&P 500 halted its own slide just shy of that mark. It was enough to put a lot of investors and analysts on edge and start to wonder if the good times were finally coming to an end.
What a difference a week makes! After closing out the worst October, and one-month period in a decade, the market has rebounded strongly over the last week. The Dow is up a little over 6.6%, the NASDAQ 8.3%, and the S&P 500 6.7% in that time. This week may have provided an unexpected catalyst for the market to push back and retest the all-time highs set in late September. Mid-term elections on Tuesday left Democrats in control of the House of Representatives, while Republicans kept their spot in the driver’s seat in the Senate.
Depending on your political view, a divided government may not be a good thing; major reforms or initiatives from either side of aisle become more difficult without one party in control of both houses of government. It isn’t unreasonable to suggest that one of the reasons President Trump could afford to be as confrontational as he has, with a consistent, “my way or the highway” attitude about everything from tax reform, trade and most certainly his major staff advisors and political appointees is because Republicans controlled Congress and the Senate. That usually meant that even if a lot of Republicans and conservatives criticized his approach, the party at large generally fell into line behind him.
As an investor, it’s not always easy to separate investing discipline and objectivity from political opinion and preference. That becomes harder when politics have a clear and direct impact on economic progress and market behavior. The Tax Reform Act at the end of last year is a good example; the tax savings that became available almost immediately to corporate America were certainly a catalyst for the market’s recovery from its first correction at the beginning of the year. In that light, the impact that midterm elections has on the market now could come from the government’s likely inability for the next couple of years to push any major changes.
I’ve always believed that if there is anything the market really doesn’t like, and is most likely to react negatively to, it’s change. Investors like predictability, and we rely on measurements that offer a certain level of reliability to guide investment decisions. The status quo means that the things we use to drive our decisions remain relatively constant, and we don’t have to worry as much about changing our method or our approach. When something threatens to change the investing landscape, investors naturally get nervous.
After eight years of a long, sustained bullish run that made a lot of investors think the easiest and best way to make money way in the stock market was to buy a passive index fund and just let it ride – “invest it and forget it,” if you will – the market rediscovered volatility this year. A big part of that was influenced by openly aggressive and confrontational politics from the Trump administration. Tariffs imposed every one of America’s largest and most important trading partners may indeed prove to have been the right move in the long run, but the tensions that came from seeing those long-standing trade relationships continue to keep the market on edge. A split government may not be able to put the cat back int the bag of things the Trump administration has already put back in place, the lack of consensus is also likely to make continued progress and changes that much harder to come by. The hope that the market seems to be keying on right now is that a natural check from a split House against the Oval Office could help restore the status quo and give investors a return at least some kind of predictability that can help keep the stock market’s bullish trend in place.
Assuming this happens, it’s entirely possible that the market could stage yet another broad-based rally to a new set of all-time highs. Which are the sectors that might be the biggest beneficiaries? I think there are two; here they are.
While a divided House may blunt many of the reforms and initiatives the Trump administration still has plans for, one of the things that both sides seem to agree on is the need for improved infrastructure. A major spending bill may be hard to come by, but any progress on this front should act as a positive for this sector. Consider also that tariff and trade concerns have put major pressure on the sector throughout the year; even with the sector’s rebound since the end of October, which is about 10% from October 30th to now as measured by the SPDR Industrial Sector ETF (XLI), it remains down by a little over 10% from its 52-week highs. That gives the industry lots of room to rally even more, with increased chances that the absence of political complications could contribute even more.
This sector has been one of the biggest underperformers throughout the year, as pricing and supply pressures among chipmakers have pushed stocks lower. A major argument for the President’s aggressive trade stance towards China has centered around the semiconductor industry and concerns about intellectual property protections and even theft. Many of the pricing pressures that have pushed semi stocks lower may not abate quickly. I also think, however that a changed political reality could force the Trump administration to try to make a trade deal with China more quickly than it might do otherwise; and I would expect that to provide at least an emotional reason for investors to start making new bets on a sector that has been beaten down by almost 15%, based on the Ishares Semiconductor ETF (SOXX) from its 52-week highs.