US: Three implications of the blue wave – Morgan Stanley

Stocks rallied a day after violence rocked the US Capitol, with investors firmly focused on Democrats' win of the Senate after the elections in Georgia, shrugging off the storming of the Capitol by supporters of President Donald Trump.

Andrew Sheets, Chief Cross-Asset Strategist at Morgan Stanley, explains why a Democrat sweep of Congress and the White House suggests more reflation and rotation in portfolios.

Key quotes

“We're constructive for 2021 and expect solid returns. But a key risk to this story would be that we're underestimating the risks of a new COVID-19 variant or a slow vaccination program and that policymakers don't meet these challenges with further support. The 'and' in that previous sentence is really important. Additional policy help makes it much easier for the market to look through these challenges, as we saw last year. The Georgia results are important for this scenario because they make it much more likely that Congress would take action, and quickly if the economy evolved worse than our current base case.”

“We think there's a good chance that the new Congress will push for up to $1 T in additional economic support, including $2000 direct payments, even if the economy doesn't go through a new additional deterioration. That would provide further support to the recovery, and importantly, drive more confidence that inflation can rise from currently depressed levels. We think US growth and inflation will both exceed expectations this year, and our investment preferences are heavily skewed towards areas of the market that would benefit if this came to pass.”

“There's a theory that markets are efficient and immediately move to price in all new available information. But in this case, I really don't think that holds. This was a genuine surprise, and even active political observers saw these races as extremely close. Meanwhile, we think many investors had penciled in divided government as a base case for 2020 following the November elections. It would shock me if all of those views were able to completely adjust in just a day or two.”

“We think the Georgia election results reduce one downside risk to the market and raise the chances for higher growth and higher inflation in 2021. And what are the risks? Higher growth and inflation should, ultimately, drive longer-run interest rates higher, and drive a shift in leadership between assets that benefit from this, and those that do not. We like financials, as an inexpensive sector that offers some diversification against a higher interest rate scenario, and we remain underweight government bonds.”