What Georgia’s election means to markets

In 2016, bank stocks rose while technology stocks initially fell and then lagged behind the market a few months ago. Political students had an easy explanation: Republicans are in favor of Wall Street, while Silicon Valley is a progressive bastion.

Easy, but wrong, as the Georgian Senate vote showed. Investors’ response to the Georgia vote was to buy banks and sell Big Tech.

Of course, politics has changed, and Facebook and Amazon are now being treated like bad guys by many on the left. They would be the biggest losers in the corporate tax cuts that President-elect Joe Biden promised to partially reverse. The possibility of higher taxes on capital gains with a Senate controlled by Democrats should affect the actions that have left investors with unrealized profits.

But what really matters is something common for 2016 and today: the trade of reflection. The idea that the government will borrow and spend more, supporting the economy and bringing higher inflation, and therefore less support from the Federal Reserve. This came on Wednesday in a significant 10-year increase in Treasury yields, which brought them back more than 1% for the first time since March. Another sign was an additional increase in inflation expectations, already the highest since April 2019.

Higher bond yields help banks, just as they did after Trump’s election. They affect Big Tech, because future profits are worth less if the safe alternative is more attractive. All FANGs – Facebook, Apple, Netflix and Alphabet (necessarily Google) – have fallen, along with many smaller technology stocks.

The rest of the market shared the analysis: cyclical stocks sensitive to the economy outperformed safer defensive stocks in general, with the financial, industrial and consumer discretionary sectors doing well. The winners outnumbered those who lost in the S&P 500 by almost 4 to 1, but the simple size of Big Tech meant that the overall index struggled, rising by only 0.6%. The Russell 2000 index of smaller companies is less dominated by such growth-oriented companies and increased by 4% even as its growth stocks declined.

It is worth noting where politics has a more direct effect. Anything related to the environment has jumped every time the Democrats’ outlook improves, as regulations and subsidies become more likely to benefit companies. Senate control makes it easier to appoint heads of agencies who will promote the agenda through regulations because they cannot be filibustered.

The Invesco Solar ETF is an imperfect measure of President-elect Joe Biden’s support, as it includes a lot of foreign stock, but jumped on Georgia’s results, rising by more than 8%. (Electric carmaker Tesla has also risen again, but it lives up to the hopes and dreams of its shareholders, and rational explanations may not apply.)

The question is whether this is yet another false dawn for reflection. Investors have been expecting inflation and higher bond yields every year for two decades and have largely been wrong. After Mr. Trump’s election, he failed to live up to his promises to spend more on infrastructure, instead focusing on corporate tax cuts. This brought deficits, but little growth in the economy and no increase in inflation. Banking stocks lagged behind the S&P 500 in 2017, while Big Tech and other growth stocks had a very successful year.

Even winning both places in Georgia does not mean that Mr. Biden will be able to move to the left – or that he wants to. Every Democratic senator is needed to promote any rejection of Republicans, which means each has a veto. Centrist senators will certainly block everything they think is going too far, including much of the Green New Deal spending trumpeted by the party’s left.

So far, the scale of the move shows that the market does not value Mr. Biden’s control over the Senate too much. A significant additional stimulus would likely be added to the cyclical inventory rally, while Big Tech would likely lag behind.

But investors have learned a lesson from the last decade: when there is nothing specific to increase bond yields, cyclical and cheap stocks, then buy bonds and Big Tech. Both are already expensive, but if Mr Biden fails to deliver, he could easily become even more so.

Write to James Mackintosh to [email protected]