Investors Once Feared a ‘Blue Wave’. Now, They Fear Something Else.

“A delayed or contested election outcome is even more unsettling,” UBS says.

Joe Biden (Olivier Douliery/Bloomberg)

Joe Biden

(Olivier Douliery/Bloomberg)

Just a few month ago, investors seemed to fear that a win for Joe Biden in the nearing U.S. Presidential election and a Democratic sweep in Congress would hurt stocks, according to UBS Group’s chief investment office. But that thinking no longer prevails.

“In the past two weeks this narrative has completely flipped, to the point where investors now view a Blue Wave as being a catalyst for a reflation trade: cyclicals and value stocks higher, a steeper yield curve, and a weaker U.S. dollar,” Solita Marcelli, UBS’s CIO for the Americas, and Jason Draho, head of asset allocation for the Americas, said in a research note dated October 9.

Biden’s lead in the race for the U.S. presidential election that’s less than a month away, along with the increased likelihood of a major fiscal stimulus package becoming Democrats’ top priority after their potential sweep, have helped change the market narrative, they said.

“Biden’s widening lead in the polls and prediction markets, and along with it the likelihood of a Blue Wave, is reducing election uncertainty,” Marcelli and Draho wrote in their note. “Investors may have initially feared a Blue Wave, but a delayed or contested election outcome is even more unsettling.”

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Odds of a pre-election fiscal deal have slipped as the probability of a Blue Wave has climbed, according to their note.

While investors have feared Biden will increase regulation and that higher corporate taxes could become a problem for them in 2022, a Blue Wave-induced reflation trade has taken over as the prevailing theme in markets, said Marcelli and Draho. The change in narrative helps explains why small-cap and large-cap value stocks recently outpaced large-cap growth as the Treasury yield curve steepened, oil rose, and the U.S. dollar weakened, they said.

“Near term volatility aside, the reflation trade has more room to run,” they wrote. “The upside potential of more stimulus is not fully priced.”

Although the probability of a Blue Wave is up, Democrats gaining control of Congress remains far from certain, according to their note. Investors are meanwhile watching for a Covid-19 vaccine.

“The good news is that data from the Phase 3 trials for three vaccines should start to arrive by early to mid-November and early indications are fairly promising,” Marcelli and Draho said. “It may take until at least mid-2021 to reach herd immunity levels in the US, but financial markets will price in the economic benefits far sooner.”