Investors find upside in split U.S. government

The market didn’t get the decisive U.S. election result it wanted Tuesday night, but investors are finding silver linings for stocks in a divided Washington.

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With Republicans likely holding onto the Senate, economic stimulus will be slower and possibly smaller, said Sam Garza, portfolio manager overseeing macro-asset allocation and collateralized loan obligation teams at DoubleLine Capital in Los Angeles, Calif.

But tax increases are also less likely in this scenario, he said in an interview Wednesday morning.

“One of the elements of a [Democratic] blue wave would probably have been tax increases, particularly corporate taxes,” Garza said. A split government might “represent a little bit of a sweet spot for assets” with tax increases off the table.

On Wednesday afternoon, key states were too close to call in the presidential race as the counting continued. While the Democrats appeared likely to hold on to the House of Representatives, the path to a Democratic Senate majority was narrowing.

“The reason why the market was looking for a unified government is that it was hopeful that larger stimulus packages could be produced. The market didn’t want to be surprised,” Garza said, noting the possibility of litigation and recounts.

As a result, markets started Wednesday morning trying to price out a Joe Biden presidency and a Republican Senate, he said.

“One of the interesting things that we’re already seeing is that interest rates have rallied, bank stocks have done worse, and tech stocks have done better,” Garza said.

“My interpretation is that having a split government reduces the odds for stimulus or makes the potential stimulus smaller than if it was a unified government.”

Less economic stimulus has led investors to favour growth stocks at one end and bonds on the other, he said. “With the outlook that there will be a little bit less growth going on in the economy, interest rates may not rise as much as folks had thought initially.”

The S&P 500 closed Wednesday up 2.2%, and the Nasdaq composite closed 3.9% higher.

In a research note Wednesday morning, CIBC World Markets chief economist Avery Shenfeld said a split Congress could lead to a stimulus bill in December, albeit for a smaller amount. House Democrats may decide there’s nothing to be gained by stalling until inauguration day in January, he wrote, if a Republican Senate could block a stimulus bill.

A Republican Senate would also mean less decisive change on other issues, even if Biden wins the White House, Shenfeld wrote.

“Those looking at the election as a turning point on climate change, energy sector policy, financial services regulations, taxation and other issues that have impacts on individual equities or other assets can count on seeing less dramatic change — if indeed any changes are in the wind.”

In another research note Wednesday, Purpose Investments chief investment officer Greg Taylor said investors should look to safer assets to wait out election uncertainty, which he said could lead to market volatility and even civil unrest.

“There are a number [of assets] that may benefit, but we believe the best options include cash, gold and hedging strategies with some options overlay,” he wrote.

Taylor took a view similar to Garza’s that while stimulus could be held up in a split government, a Democratic White House and Republican Senate could “provide the balance of power that is traditionally something markets like because it’s a more minimal change.”

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