13 October 2020
The Blue Wave is coming. Election day may lift stocks, but only after bouts of high volatility and sharp declines, strategists at Morgan Stanley said Friday.
Current polls show that Democratic presidential candidate Joe Biden will defeat President Donald Trump in November, and that the Democratic Party has a strong chance of gaining control of Congress. Nonetheless, US stocks are among the few assets ready for a “roundabout” should such a redefinition take place, the bank said in a statement to clients.
They added that while some assets, such as Treasuries and oil, will face a steady decline, an overwhelming Democratic victory will temporarily deviate from the stock's upward trajectory.
According to the company, the immediate market reaction is likely to be negative. Fears of higher taxes will lead to initial sales and lower profit prospects.
Ongoing economic recovery will lead to some decline in earnings per share ratios, creating short-term risk until earnings growth reaches updated forecasts. The bank said the uncertainty about future stimulus could also cloud initial hopes for new relief.
"We expect fiscal expansion to provide some offset [tax hikes], but until the market learns the type of fiscal expansion after the Democratic sweep, expect equity risk premiums to remain elevated until January," the strategist team wrote.
Nonetheless, Morgan Stanley said the stock should resume its rally as volatility subside and investors get a clearer picture of the Biden administration's legislative agenda. Continued economic recovery will lead to a rebound in spending and an increase in income. Follow-up to March's CARES law will raise optimism, and Morgan Stanley expects the tax panic to give way to a smaller-than-expected hike.
“Our baseline option is to buy any blue wave flop, as we believe tax policy is difficult to enact and think the legislative focus will be on CARES 2 as a top priority,” the team said.
In other outcomes, the bank believes the divided government has less pre-downturn but longer struggles with new stimulus adoption. The strategists added that the country's economic recovery could halt and disprove the optimistic forecasts of investors.