The old cliché that investors prefer divided government is in need of an update.
Stocks rallied Wednesday after Democrats won one Georgia Senate seat and were poised to take another, though trading ended before the second race was called, delivering control of the Senate to the Democrats. This goes against the conventional wisdom that stocks do best when at least one chamber of Congress is controlled by the party in opposition to the president, preventing any dramatic or radical moves that could unsettle markets.
The S&P 500 ended Wednesday up 0.6% and the Dow Jones Industrial Average rose 1.4% to a new closing high, though that was off the levels it reached earlier in the day before Washington D.C. descended into violence. Perhaps most notably, yields on 10-year U.S. Treasurys rose by .075 points to 1.03%, reflecting higher growth expectations. This gave a boost to banks and other financials, as it will allow them to earn more on loans and investments. Bank of America and Wells Fargo, two of the country’s largest lenders, soared 6.3% and 7.1%, respectively. All this was in spite of the chaos in the nation’s capital.
The tech-heavy Nasdaq Composite, however, ended the day down 0.6%. Some high-flying technology companies seen as pandemic beneficiaries were among Wednesday’s losers: Etsy fell 4.2% and Peloton declined 3.2%.
In past decades, divided government might have meant moderation and compromise in policy-making. In 2021, though, it would likely mean paralysis, which isn’t what the U.S. economy needs right now. Look no further than the prolonged negotiations over a second coronavirus-relief package, which eventually yielded a smaller-than-expected sum that came too late to save many struggling businesses as the economy entered a bleak winter.
A Democratic-controlled Senate likely means that more fiscal stimulus is on the way, not just in the form of checks to individuals but also infrastructure spending, investments in green energy and aid to cash-strapped local governments. No wonder interest rates are ticking higher.
Wednesday’s market reaction was like a mirror image of what happened after the November election, when it appeared likely that Republicans would hold the Senate, causing technology stocks to rally and cyclical stocks to falter. The S&P 500 Communication Services index, whose biggest constituents include Facebook, Google owner Alphabet and Netflix, rose 6% in the three days following that vote. The S&P 500 Industrials index, heavy in names such as Honeywell and Union Pacific, gained just 1.4% over the same period. It was only after announcements of safe and effective vaccines that cyclicals caught back up.
These early-November movements reflected an expectation not only that fiscal stimulus would remain modest under divided government, hurting industrials and other cyclicals, but also that the Federal Reserve would be left to attempt to support the economy on its own, with low rates as far as the eye can see. Exceptionally low rates tend to support speculative bets on companies with little to no free cash flow that could pay off in the distant future. With fiscal authorities getting back in the game, the Fed might not need to be so radical.
At the same time, the likely Democratic majority in the Senate will be as narrow as can be, handing considerable power to moderates such as West Virginia’s Joe Manchin. This means moves that would be negative for stocks, such as a major tax increase or an all-out assault on the fossil-fuel industry, are far less likely to succeed. Indeed oil companies were among the winners Wednesday as traders anticipated they would benefit from faster economic growth: Exxon Mobil rose 2.6% and ConocoPhillips gained 4%.
We already knew that Main Street was tired of the division and rancor in Washington. Wall Street apparently has come around to their way of thinking.
Write to Aaron Back at firstname.lastname@example.org
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