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Stocks are soaring as markets price in a split Congress

November 4, 2020, 5:22 PM UTC

Stocks rose early on Wednesday following a long election night as investors continue to wait for a victor to be declared. One reason for the boost?

“Stocks are sending the right message; stocks are interpreting what we know: The market is pricing in a split Congress today,” LPL’s Jeff Buchbinder tells Fortune, referring to the possibility of Republicans holding control of the Senate and Democrats controlling the House. “That has major implications for tax policy, which is probably the No. 1 market issue with regard to the election.”

The S&P 500 is trading up over 3.3% in midday trading, while the Dow is up nearly 3%.

To be sure, one of investors’ big fears in recent months, a contested election, has reemerged as a possibility. Though as of Wednesday morning the election is not contested (it simply hasn’t been called yet), President Trump spooked U.S. stock futures when he falsely claimed in a speech he had won the election even though millions of votes are still being counted, and said he would enlist the Supreme Court to stop ballot counting.

But Lisa Shalett, Morgan Stanley Wealth Management’s chief investment officer, believes that while a contested election could set markets up for a rocky couple of weeks (Wall Street analysts have argued a contested election would create post-election volatility if the race is dragged out), investors are largely “looking through the windshield as opposed to looking down at the ground and skiing the mountain” in front of them.

“It’s clear from the way markets are behaving that they care about Congress,” Shalett tells Fortune. “At this point I think they recognize if it’s Biden, he’s not going to have much room to do anything, which is kind of status quo, and if it’s Trump, it’s status quo.”

As of the writing of this article, the Senate election is in a dead heat, with 47 Democrat seats and 47 Republican seats, with several more yet to be called, per AP. LPL’s Buchbinder notes stocks historically perform better in a divided government environment, while major tax increases are “probably off the table” if the Senate remains in Republican hands—something that has vexed Wall Street.

It’s too soon to know which parties will take control of the House and Senate, but now some on the Street are arguing the most likely outcome would be a Biden presidency and a divided Congress: UBS estimates the probability of a Republican Senate has “increased,” analysts wrote in a note Wednesday. That could result in “the uncomfortable position of another two years of gridlock in Washington, probably a less generous fiscal stimulus, and a higher burden on the Fed to stimulate the economy,” Joachim Klement, head of investment research at London-based Liberum, wrote in a note Wednesday. In that case, he argues, “stock markets face a period of heightened uncertainty in the near term,” but “medium- to long-term consequences are likely to be negligible,” he believes.

Many market prognosticators were anticipating a “blue wave,” in which Biden won the presidency and Democrats flipped control of the Senate. That scenario, they believed, could be a boon for big stimulus spending and, as a result, stocks.

In fact, those like Morgan Stanley’s Shalett argue that while markets would “hate” a contested election, “they would hate it not because they care if it’s Biden or Trump, but more because it means the lame-duck session of Congress will not probably…pass stimulus. It means the stimulus gets pushed,” she says.

A new package would likely be passed regardless of who won the White House, but its size and timing would be determined by who controls the executive branch and, importantly, Congress. In that sense, the worry as we wait for election results is that “Washington is going to be in chaos until January, and we won’t get the fiscal stimulus. That’s the risk,” Shalett says.

For now, clarity on the presidential election might not come for days.

But both Buchbinder and Shalett argue investors aren’t as concerned as voters might be. “For markets, the legislative environment, what can actually get done in Washington matters more,” Buchbinder says.

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