What a divided Congress means for the markets

The pollsters and political pundits may have whiffed on their enthusiastic forecasts of a Democratic “blue wave,” but the financial markets are adjusting in stride to what appears to be at least two more years of a divided Congress.

While the bond market was whipsawed from first anticipating a Democratic sweep of the White House and both houses of Congress, it appeared to settle in on Wednesday to the reality that any fiscal stimulus package will be more conservative and inflation is in check for now.

The equity markets, meanwhile, rallied strong, led by healthcare and technology sector stocks, but also saw laggards by alternative energy companies that might have benefited if Democrats had total control.

“Bond yields are down because we’re adjusting growth and inflation expectations lower because we’re probably not getting the level of fiscal stimulus that was expected,” said Kathy Jones, chief fixed income strategist at Charles Schwab Corp., speaking Wednesday morning during a panel discussion as part of the Schwab Impact virtual conference.

She pointed out that the corporate bond market was among the most stable because a divided Congress makes the sweeping tax hikes promised by Democrat Joe Biden less likely.

The slower economic growth likely resulting from an ultimately smaller stimulus package also pushes off until after 2023 the chances of an interest rate hike by the Fed, she explained.

The post-election stock market rally, which saw the S&P 500 Index up more than 3% in mid-day trading, reflected the pursuit of growth in an environment where the catalysts have not changed, according to Liz Ann Sonders, Schwab’s chief investment strategist.

She listed the catalysts for stock market activity as the resurgence of the virus, uncertainty around fiscal stimulus, and election uncertainty. Beneath the broad market performance, Sonders pointed out the strength of the technology and healthcare sectors and the lagging performance from the materials and financials sectors.

On the tech-stock rally, she said, “They offer defensive characteristics in the sense that this is where you can find growth. And growth becomes more valuable when it’s very hard to find.”

Michael Townsend, head of legislative and regulatory affairs at Schwab, said the divided Congress “will make it difficult for whoever wins the presidential election to get an agenda through Congress.”

Townsend’s key takeaways from the preliminary election results are that he doesn’t expect any fiscal stimulus to be passed before the inauguration in January, infrastructure spending might be an area of political consensus, and there will be continued scrutiny on big tech.

“Both parties dislike big tech for different reasons,” he said. “Democrats have focused more on the antitrust side, and Republicans have focused more on the perceived bias by tech companies. Big tech companies will look at this outcome and say one thing not likely to happen is a big breakup, which is something Democrats have talked about.”

In terms of new tax legislation that was widely promised by Biden throughout the campaign, Townsend said, “The bigger question is what won’t happen.”

“A day or two ago we were talking about a potential blue wave that could lead to higher taxes across the board, as well as packing the Supreme Court,” he said. “Those are completely off the table now, and taxes are not likely to change.”

In terms of the international markets, Schwab’s chief global investment strategist Jeffrey Kleintop, said the alternative energy movement took a big hit. “No blue wave means green stocks are in the red,” he said, citing as an example a 7% mid-day price decline by First Solar (FSLR).

“One area not fairing well today is green stocks,” he said, citing the contrast of the MSCI Global Alternative Energy Index outperforming traditional energy stocks over the past three months by 80 percentage points.

Ultimately, as the financial markets adjusted to the unfolding election data, Townsend said the biggest loser again might be the pollsters and pundits that produced a near-repeat of their 2016 missed forecast by calling for a Democratic landslide that never transpired.

“There will be a real reckoning and it will be hard to build back confidence that these polls mean anything,” he said.