One view from Morgan Stanley favors all Ds or all Rs. This one emphasized low the importance of a stimulus. My own opinion is that continuing with the heavy stimulus is digging too much of a debt/deficit black hole.
Blue Sweep—Buy the Dip
The conventional wisdom has long been that Democratic control is a drag on U.S. equities given the potential for higher taxes and greater regulation—and, in the short term, this would likely weigh on equities. Morgan Stanley forecasts that the S&P 500 would sink to 3100 between the election and the presidential inauguration in early January, given a Blue Sweep, versus 3600 for a Red Redux or roughly 3400 for the two other scenarios.
Yet, market cycles ultimately matter more than policy shifts tied to election outcomes. “While we think the S&P 500 would initially trade lower in a Blue Sweep scenario, as rates rise, we'd ultimately view this as a 'dip to buy', with a bull market still intact," says Sheets.
Looking at equities elsewhere, overseas markets would likely see an immediate lift, if the election puts Democrats in control. A Blue Sweep could particularly favor European equities because, among other reasons, investors are likely to view Europe as a good relative value in light of increased U.S. fiscal spending and tax policy reform.
A Democratic sweep may also benefit emerging market equities, given its association with expectations for more infrastructure spending and rising long-end yields. One notable exception is Russia, which could face oil-price downside and rising investor concern about Russia-specific sanctions risks.
Red Redux—Tax-Driven Stimulus Abounds
In the event of a Republican sweep, equity markets could respond favorably, with the S&P 500 rising from current levels between the election and the inauguration. Telecoms, U.S. energy and asset managers would likely get a boost from expectations for continued deregulation.
European equities may also rally on a Red Redux, with healthcare stocks leading the way. Longer term, however, the relative case for Europe and other global markets might not be as favorable under this scenario, compared with a Blue Sweep.
Either way, a unified government would likely entail the strongest fiscal stimulus measures. A growing budget deficit would hit Treasury prices and push up interest rates. This creates a potential detour (i.e., buying opportunity) for corporate credit. “The net result is likely to support credit performance, although the initial move higher in Treasury yields may hurt total returns and fund flows," Sheets notes.
Blue Tide and Thin Red Line—Gridlock Creates Detours
While the outcome of the U.S. presidential election has many implications for Americans and foreign policy, the market perception of a divided government, no matter who controls the White House, is gridlock. If the election yields a divided government, investors should plan for market detours in many asset classes.
In a Blue Tide or Thin Red Line, the S&P 500 could hover around current levels on Inauguration Day. “An economy in recovery, but with some market doubt around the ultimate strength of that recovery, is most likely the status quo," says Zezas, noting that rates are less likely to rise under this scenario, providing some valuation support.
Over the longer term, however, divided power may carry more risk, particularly for credit and equities. “Yes, such a scenario lowers the odds of changes to tax policy, but it could also lower the odds of larger fiscal stimulus, a factor we think could ultimately be more important," says Zezas, who points to the budget fights of 2011 and 2012 and the austerity that followed. “Despite low rates, equity valuations went lower, not higher."
