Admittedly, I don’t so much enjoy the days ahead of US elections.
It’s very difficult, bordering on the impossible, to write about much else, not because I’m consumed by election speculation, but because everyone else is.
One of the more tedious tasks ahead of US presidential ballots is gaming out the market reaction for four different scenarios: Democratic president, split government; Republican president, split government; Democratic sweep; Republican sweep.
I used to enjoy that part of the pre-election tedium, but that was before I began committing scenario analyses to the written word. It’s irksome to spell out a quartet of election scenarios knowing full-well that three of them are a waste of time.
Rightly or wrongly, markets have come to the conclusion in 2024 that only two outcomes are worth serious consideration: A “red sweep” and “Harris with divided government.” The latter would be a “vol killer,” a bull flattener and status quo D.C. gridlock. The former would be a cyclical rally, a bear steepener and the end of the world. (I’m just kidding on the armageddon part. Maybe.)
If you’re wondering what Morgan Stanley’s Mike Wilson thinks about the those two outcomes, he weighed in on Monday. Below, find his quick takes on “red sweep” and Harris-Gridlock, for whatever they’re worth to you.
What happens in a Republican sweep scenario? Initially, it depends on rates and the composition of the rate move, in our view. If yields stay somewhat contained in the days following the election outcome being known (i.e., 10-year yield not up more than ~20bps) and a move higher is driven by better nominal growth expectations, cyclicals (Financials, Industrials and commodity-sensitive industries) can outperform and take indices higher. Conversely, if the move higher in yields is more material and is driven by a rising term premium due to fiscal sustainability considerations, we would expect more of a risk-off posture like last summer/fall. Stocks started to take notice of this risk last August when the term premium was up ~50bps from the June ’23 lows (we’ve seen a similar increase since the mid September ’24 lows). That said, last year’s move continued well beyond that ~50bp increase as the term premium rose by ~140bps in total through last October. The downside in equities over this period coincided with the material increase in term premium beyond the initial ~50bps rise. We see tariff-sensitive consumer equities underperforming in this election scenario.
What happens in a Harris win + divided Congress scenario? We see tariff-exposed consumer equities and renewables outperforming in this outcome. A fall in rates in this scenario, should it play out, could also benefit housing-sensitive consumer stocks and higher beta growth equities. Financials, Industrials and commodity-sensitive industries could underperform initially. That said, we would expect this initial move to be modest given our prior work, which suggests that the long leg of the Republican win trade really did not move all that much in October outside of Financials (which were driven more by solid 3Q earnings). Nevertheless, Financials could see some modest underperformance near-term on the idea of potentially stiffer regulations compared to a Trump presidency. In our view, market leadership in the divided congress outcomes will likely come down to the business cycle, the Fed’s reaction function, and industry-specific fundamentals following the election.
As for an unlikely “blue sweep,” Wilson gingerly noted that, “the equity market could initially trade cautiously given the prospects for higher corporate taxes.”
