Market Impacts: from Midterms to Second Half
CME: Micro E-Mini Nasdaq 100 (
MNQ1!)
On August 17th, I published “Market Impacts of US Midterms Elections”. Thanks to your support, it made it to “Editors’ Picks” and was featured in TV Digest newsletter in an email themed “Midterms are Coming” to all subscribers.
With the midterm elections coming to an end, it’s a good time to reassess the situation, exploring potential changes in economic policies which may give rise to trading opportunities.
In the August 17th story, we have discussed 3 potential outcomes of the midterm election:
• Party Government: The President, the House and the Senate are controlled by the same political party
• Divided Government: Only one chamber of Congress aligns with the President
• Opposing Government: The President and the Congress are from different political parties
Before the elections, the Democratic Party controls the White House and both chambers of the Congress. It was clearly a “Party Government” under our definition.
As of this writing, Democrats clinched 50 seats in the Senate. With the tiebreaking vote from Vice President Harris, Democrats retain Senate majority. Meanwhile, Republicans lead 212:204 in the House race but has not reached the magic 218 required to flip controls.
GOP represent half of the voters in this election. They hold on to at least 49 seats in the Senate, gain more seats in the House, and are likely to retake control. They also have governorship in half of the 50 States.
So, why the Midterms are being perceived as a landslide victory for Democrats?
It’s all about expectations. Historically, midterms are bad for the ruling party. Whichever party in the White House usually loses seats in the Congress. In the 2018 midterms, Nancy Pelosi led the Democrats to recapture the House of Representatives. With Biden’s approval rate hovering at 40% low, and inflation rate flying high, GOP was widely expected to have a stunning victory at both chambers of the Congress.
To the Democrats, the absence of “Red Waves” is a vindication of their political agenda. While a “Divided Government” is still possible pending final results, Biden and Senate Majority Leader Chuck Schumer already claimed election victory.
Conclusion: the emboldened Democrats will go full speed with “Build Back Better” in the second half of President Biden’s presidency.
Bigger Spending
In the last two years, the Biden Administration passed legislations with budget over $4 trillion. These include:
• American Rescue Act in March 2021, $1.9 trillion
• Infrastructure Investment and Jobs Act in November 2021, $1.2 trillion
• U.S. Chip and Science Act in August 2022, $280 billion
• Inflation Reduction Act in August 2022, $757 billion
Also in August 2022, the Administration announced a Student Loan Forgiveness Plan that is expected to cost $400 billion. The plan is currently on hold by court orders.
In the First Half, new budget items averaged $2 trillion a year. I expect more big budget items to come in the Second Half. If Republicans are not there to slow down the legislative ambitions, it’s hard to tell how big the spendings will be.
Bigger Deficit and Bigger Debt
According to USDebtClock.org, the 2022 Federal Tax Revenue is estimated at $4.92 trillion, and the Federal Spending Budget will be $5.98 trillion. The shortfall is Federal Budget Deficit, at $1.06 trillion.
The largest federal budget items are:
• Medicare/Medicaid, $1.490 trillion, (24.9%)
• Social Security, $1.231 trillion, (20.6%)
• Defense/War, $770 billion, (12.9%)
• Interest on Debt, $481 billion, (8.0%)
I notice that debt interest has risen by $39 billion from previous estimate, and its share in the federal budget grows from 7.4% to 8.0%, thanks to the Fed rate hikes.
US National Debt is estimated at $31.3 trillion. Budget deficit needs to be financed by debt. Therefore, national debt would rise to $32.5 trillion next year at a minimum.
While many bonds were issued before 2022 and carried low yields, new Treasury bonds must pay current market rates. Considering Fed Funds already at 4%, I put 3% down as my estimate for weighted-average federal debt service rate in 2023. This would price the annual debt interest at $975 billion, which is 103% higher than this year, and $205 billion more than the Defense budget!
With Democrats in control, I expect Medicare, Medicaid, and Social Security to get favorable budget allocation next year. Heightened geopolitical tensions in multiple fronts justify a bigger Defense budget. Assuming all of them goes up by 5% and there is no change in other budget items, my baseline forecast for 2023 federal budget is $6.65 trillion, an 11% annual increase.
Assuming tax revenue goes up by 10%, we will have a budget deficit of 1.23 trillion, a 24% jump from 2022. Big spending legislations could add $1 trillion more on top of this.
Sticky High Inflation
The US economy is caught between restrictive monetary policies and expansive fiscal policies. When trillions of dollars are flooding the economy and the financial system, prices of goods and services tend to go up. Raising interest rates alone is not sufficient to bring the price level down.
This is why inflation is still uncomfortably high after six consecutive rate hikes. Cathy Wood recently flowed an idea claiming inflation could turn negative next year, citing similarity from the Roaming Twenties. I peg to differ.
The Federal Government is pumping $6-7 trillion in a $26 trillion economy. Every year, federal agencies and contractors get bigger budget, government employment grows, and federal employees get higher wages. Regardless of the business cycle, one quarter of the US economy is expanding. Industries benefiting from government spending will strive, even if the country may slip into a recession.
Higher Taxes
Big spending comes with bigger taxes. Government needs more tax revenue to pay for its ambitious agenda.
• Higher tax rate on people earning $400,000 or more. New taxes on investment carry interest, translating into headwinds for hedge fund, private equity, and venture capital.
• The 15% minimum corporate tax will affect multinational corporations which frequently use offshore tax haven.
Potential Winner
Unlike political elections, it is tricky to find a clear winner in the financial market.
Comparing the performance of major US stock market indexes, the Dow has a year-to-date return of -7.18% as of November 11th, while S&P 500 and Russell 2000 yield -15% and -14.14%, respectively. Nasdaq 100 falls 25.10% and is the worst performer.
Big Tech is laden with bad news these days, with missed earnings and widespread layoffs among them. As stock prices are beaten down, valuations become more reasonable. In my opinion, advanced technologies that align with government priorities would benefit in the next two years. Clean energy, artificial intelligence, biotechnology, space technology and electric vehicles are on the receiving end of major government funding. While I was bearish with the Nasdaq at 13,500, I think it could find price support at 10,500.
However, impacts from the Midterms interact with business fundamentals, the ever-changing investor sentiments, and major global events. The next Fed meeting is only two weeks away. Let’s wait for the next rate decision, as it is the overarching factor that guides market direction right now.
We can put CME Micro E-Mini Nasdaq 100 Futures (MNQ1!) on the watch list today. MNQ has a notional value of $2 times the index. At 11,792, each contract is valued at $23,584. Opening a Long or Short position requires initial margin of $1,500.
While the S&P 500 is trending down, certain sectors may outperform the broad market. CME recently launched E-mini S&P Biotechnology Select Industry Futures (CME:SXT1!) and E-mini PHLX Semiconductor Sector Futures (CME:SOX1!). They each offer more precise trading opportunities tailored to industries benefiting from increased government funding.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs tradingview.com/gopro/
MNQ1!)On August 17th, I published “Market Impacts of US Midterms Elections”. Thanks to your support, it made it to “Editors’ Picks” and was featured in TV Digest newsletter in an email themed “Midterms are Coming” to all subscribers.
With the midterm elections coming to an end, it’s a good time to reassess the situation, exploring potential changes in economic policies which may give rise to trading opportunities.
In the August 17th story, we have discussed 3 potential outcomes of the midterm election:
• Party Government: The President, the House and the Senate are controlled by the same political party
• Divided Government: Only one chamber of Congress aligns with the President
• Opposing Government: The President and the Congress are from different political parties
Before the elections, the Democratic Party controls the White House and both chambers of the Congress. It was clearly a “Party Government” under our definition.
As of this writing, Democrats clinched 50 seats in the Senate. With the tiebreaking vote from Vice President Harris, Democrats retain Senate majority. Meanwhile, Republicans lead 212:204 in the House race but has not reached the magic 218 required to flip controls.
GOP represent half of the voters in this election. They hold on to at least 49 seats in the Senate, gain more seats in the House, and are likely to retake control. They also have governorship in half of the 50 States.
So, why the Midterms are being perceived as a landslide victory for Democrats?
It’s all about expectations. Historically, midterms are bad for the ruling party. Whichever party in the White House usually loses seats in the Congress. In the 2018 midterms, Nancy Pelosi led the Democrats to recapture the House of Representatives. With Biden’s approval rate hovering at 40% low, and inflation rate flying high, GOP was widely expected to have a stunning victory at both chambers of the Congress.
To the Democrats, the absence of “Red Waves” is a vindication of their political agenda. While a “Divided Government” is still possible pending final results, Biden and Senate Majority Leader Chuck Schumer already claimed election victory.
Conclusion: the emboldened Democrats will go full speed with “Build Back Better” in the second half of President Biden’s presidency.
Bigger Spending
In the last two years, the Biden Administration passed legislations with budget over $4 trillion. These include:
• American Rescue Act in March 2021, $1.9 trillion
• Infrastructure Investment and Jobs Act in November 2021, $1.2 trillion
• U.S. Chip and Science Act in August 2022, $280 billion
• Inflation Reduction Act in August 2022, $757 billion
Also in August 2022, the Administration announced a Student Loan Forgiveness Plan that is expected to cost $400 billion. The plan is currently on hold by court orders.
In the First Half, new budget items averaged $2 trillion a year. I expect more big budget items to come in the Second Half. If Republicans are not there to slow down the legislative ambitions, it’s hard to tell how big the spendings will be.
Bigger Deficit and Bigger Debt
According to USDebtClock.org, the 2022 Federal Tax Revenue is estimated at $4.92 trillion, and the Federal Spending Budget will be $5.98 trillion. The shortfall is Federal Budget Deficit, at $1.06 trillion.
The largest federal budget items are:
• Medicare/Medicaid, $1.490 trillion, (24.9%)
• Social Security, $1.231 trillion, (20.6%)
• Defense/War, $770 billion, (12.9%)
• Interest on Debt, $481 billion, (8.0%)
I notice that debt interest has risen by $39 billion from previous estimate, and its share in the federal budget grows from 7.4% to 8.0%, thanks to the Fed rate hikes.
US National Debt is estimated at $31.3 trillion. Budget deficit needs to be financed by debt. Therefore, national debt would rise to $32.5 trillion next year at a minimum.
While many bonds were issued before 2022 and carried low yields, new Treasury bonds must pay current market rates. Considering Fed Funds already at 4%, I put 3% down as my estimate for weighted-average federal debt service rate in 2023. This would price the annual debt interest at $975 billion, which is 103% higher than this year, and $205 billion more than the Defense budget!
With Democrats in control, I expect Medicare, Medicaid, and Social Security to get favorable budget allocation next year. Heightened geopolitical tensions in multiple fronts justify a bigger Defense budget. Assuming all of them goes up by 5% and there is no change in other budget items, my baseline forecast for 2023 federal budget is $6.65 trillion, an 11% annual increase.
Assuming tax revenue goes up by 10%, we will have a budget deficit of 1.23 trillion, a 24% jump from 2022. Big spending legislations could add $1 trillion more on top of this.
Sticky High Inflation
The US economy is caught between restrictive monetary policies and expansive fiscal policies. When trillions of dollars are flooding the economy and the financial system, prices of goods and services tend to go up. Raising interest rates alone is not sufficient to bring the price level down.
This is why inflation is still uncomfortably high after six consecutive rate hikes. Cathy Wood recently flowed an idea claiming inflation could turn negative next year, citing similarity from the Roaming Twenties. I peg to differ.
The Federal Government is pumping $6-7 trillion in a $26 trillion economy. Every year, federal agencies and contractors get bigger budget, government employment grows, and federal employees get higher wages. Regardless of the business cycle, one quarter of the US economy is expanding. Industries benefiting from government spending will strive, even if the country may slip into a recession.
Higher Taxes
Big spending comes with bigger taxes. Government needs more tax revenue to pay for its ambitious agenda.
• Higher tax rate on people earning $400,000 or more. New taxes on investment carry interest, translating into headwinds for hedge fund, private equity, and venture capital.
• The 15% minimum corporate tax will affect multinational corporations which frequently use offshore tax haven.
Potential Winner
Unlike political elections, it is tricky to find a clear winner in the financial market.
Comparing the performance of major US stock market indexes, the Dow has a year-to-date return of -7.18% as of November 11th, while S&P 500 and Russell 2000 yield -15% and -14.14%, respectively. Nasdaq 100 falls 25.10% and is the worst performer.
Big Tech is laden with bad news these days, with missed earnings and widespread layoffs among them. As stock prices are beaten down, valuations become more reasonable. In my opinion, advanced technologies that align with government priorities would benefit in the next two years. Clean energy, artificial intelligence, biotechnology, space technology and electric vehicles are on the receiving end of major government funding. While I was bearish with the Nasdaq at 13,500, I think it could find price support at 10,500.
However, impacts from the Midterms interact with business fundamentals, the ever-changing investor sentiments, and major global events. The next Fed meeting is only two weeks away. Let’s wait for the next rate decision, as it is the overarching factor that guides market direction right now.
We can put CME Micro E-Mini Nasdaq 100 Futures (
MNQ1!) on the watch list today. MNQ has a notional value of $2 times the index. At 11,792, each contract is valued at $23,584. Opening a Long or Short position requires initial margin of $1,500.While the S&P 500 is trending down, certain sectors may outperform the broad market. CME recently launched E-mini S&P Biotechnology Select Industry Futures (CME:SXT1!) and E-mini PHLX Semiconductor Sector Futures (CME:SOX1!). They each offer more precise trading opportunities tailored to industries benefiting from increased government funding.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs tradingview.com/gopro/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
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