Dow falls on first trading day of the year
New York (CNN Business)Main Street is emerging as a clear winner following the Senate runoffs in Georgia. The outlook is far murkier, on the other hand, for Wall Street.
If Jon Ossoff holds onto his lead in Georgia, the Democrats will have flipped the Senate. That would give Democrats control of the White House and Congress for the first time in a decade.
A change in power in Washington would allow the real economy and job market to recover faster from the worst pandemic in a century. That’s because Democrats will likely have enough votes to provide another round of Covid relief to small businesses and lower and middle-income Americans.
“If the Democrats achieve control of the Senate, more aggressive stimulus would likely be pushed through in the short run, leading to a faster revival in the economy,” David Kelly, chief global strategist at JPMorgan Funds, wrote in a note to clients Tuesday.
After Democrats’ very good night in Georgia, some economists are already penciling in a lower unemployment rate and stronger GDP for this year and next. That’s great news for Main Street.
A faster economy and more stimulus should boost the stock market. That thinking helped lift the Dow 500 points, or 1.7%, to record highs Wednesday. The small-cap Russell 2000, which is extremely sensitive to the real economy, spiked 4%.
However, a Democratic takeover of the Senate also poses some risks for Wall Street.
Investors, who had been banking on gridlock in 2021, are suddenly worried about the risk of tax hikes and a crackdown on Big Tech, the superstar of the stock market. Tech stocks, and the market overall, could be hurt if a faster economic recovery allows the Federal Reserve to lift interest rates out of the basement sooner than anticipated.
And the prospect of even more spending by Uncle Sam is hurting bond prices, driving the 10-year Treasury rate above 1% for the first time in March. That could just be the beginning, suggesting stocks may finally face competition from boring bonds.
“The impact for stocks is likely to be a net negative,” said David Page, head of macro research at AXA Investment Managers.
GDP is stronger under Democrats
History supports the idea that Main Street could benefit more than Wall Street from the Georgia Senate runoffs.
Out of all political scenarios, the real economy has performed the strongest since 1948 when Democrats have control of the White House and Congress, according to CFRA Research. With Democrats in charge, GDP has grown at a brisk annual clip of 4.3% over that span — the only scenario where growth eclipsed 4%.
Even though many would assume Republicans are better for the economy (low taxes, less regulation), GDP grew by a more modest 2.7% when Republicans had unified control of the government, according to CFRA.
The stock market has done well when Democrats control Washington — but not as well as when Republicans rule or when there is gridlock. Since 1933, the S&P 500 has averaged 9.8% when Democrats have unified control, compared with 13.6% when there is a Democratic president and split Congress, according to CFRA.
It’s important to remember that Democrats hardly have a super majority in Congress. They lost seats in the House of Representatives and the Senate could be tied 50/50, with Vice President-elect Kamala Harris breaking the deadlock.
That means Democrats won’t have enough votes to dramatically raise taxes, enact the Green New Deal or pass other sweeping measures that would rattle Wall Street — unless they get rid of the Senate’s filibuster rules, an idea that has gained some momentum in recent months but that moderate Democrat Joe Manchin opposes.
“The most egregious or expensive policies will not be passed,” Tobias Levkovich, chief US equity strategist at Citigroup, wrote in a note to clients Wednesday.
One big question mark is whether Democrats would try to hike the 21% corporate tax rate, especially in the midst of a shaky economic recovery.
President-elect Joe Biden has proposed lifting the corporate tax rate to 28%. However, analysts said it’s far more likely the rate will rise to just 25%. That would be a negative for stocks — but hardly a nightmare.
More help could be on the way
What’s clearer is that if Democrats retake the Senate, they will be primed to provide more aid to an economy that may very well need it.
Biden has described the $900 billion stimulus package enacted last month as a “down payment” — and he may now have the votes to make that a reality.
With Democrats in charge of the Senate, Goldman Sachs expects Congress will enact another $600 billion of stimulus “in the near term.”
Others on Wall Street are projecting even more help. Jefferies said Wednesday it assumes another $1 trillion of stimulus in the next few months — a package that would boost GDP growth by about two percentage points over the next two years.
That relief package would include boosting the $600 stimulus checks to $2,000, extending enhanced unemployment benefits to the end of June and about half a trillion dollars of state and local aid, according to Jefferies.
“The labor market will heal faster,” Aneta Markowska, chief financial economist at Jefferies, wrote in a note to clients.
The unemployment rate could dip below 5% by the end of this year and hit 4% by mid-2022, Jefferies said.
Liftoff for the Fed in 2023?
If Democrats control the Senate, they may even be able to push through a long-elusive infrastructure package to repair roads, bridges and airports worth trillions of dollars.
The hope is that all of this expensive aid for the economy will help narrow the gap between rich and poor — a troubling divide that has worsened during the pandemic.
However, investors are already worrying about the goldilocks backdrop that juiced stock prices.
Before this week, Wall Street was betting the Fed would keep interest rates at zero until at least 2024. Rock-bottom rates hurt savers and suggest economic weakness — but they essentially force investors to gamble on risky stocks.
Yet Jefferies said that with Democrats in control of the Senate, inflation and the economy may be strong enough for the Fed to “lift off” in early 2023 — a full year ahead of forecast.
The bond market is already reacting. Jefferies expects the 10-year Treasury rate could nearly hit 2% by the end of 2021 — representing the steepest 12-month increase since 2013-2014.
“A taper tantrum is now a real risk,” Markowska said.
Higher rates would signal a healthier economy. But they will also force investors to think twice before betting on pricey stocks, which may no longer look like a slam dunk.
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