Wall Street's biggest banks are increasingly expecting a Biden-led blue wave as the election looms. Here's how they say you should position your portfolio.

Ben Winck
Oct. 13, 2020, 12:27 PM
Joe Biden.
  • As Joe Biden's lead in polls widens, Wall Street is warming to the prospect of a Democratic sweep in November.
  • Goldman Sachs and UBS recently advised clients to prepare for a shift to cyclical and value stocks from growth favorites, as a Biden victory would increase the odds of additional fiscal stimulus.
  • The yield curve could steepen as investors prepare for rising inflation and stronger economic growth, UBS added.
  • Morgan Stanley recommended investors buy a knee-jerk dip in stocks and sell long-dated Treasuries in the event of a Democratic sweep. Once investors gain insight into future tax policy, fresh stimulus would restart stocks' upward trajectory, the bank's strategists added.
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Wall Street is warming to the idea of a Democrat-led government and the tax policies, spending initiatives, and regulation it may bring.

It wasn't long ago that major banks deemed a second term for President Donald Trump the best option for the stock market. His 2017 tax law drove stronger profits, and deregulation helped companies boost efficiencies.

But polls suggest the president is lagging significantly behind the Democratic presidential nominee, Joe Biden, with little time left to eke out a lead. Meanwhile, Wall Street giants have rethought their forecasts and found reasons to believe a Democratic sweep on Election Day could drive stocks higher.

Read more: MORGAN STANLEY: Buy these 44 cheap stocks poised to surge as the economy continues to recover and reopening expands.

The market sentiment about a so-called blue wave "completely flipped" over the past two weeks, UBS said Monday. The government's failure to pass a stimulus measure makes it increasingly likely that Democrats would prioritize pushing a larger bill in January. Doing so would punt tax reform into 2022, allowing investors to reap the benefits of fresh stimulus and continued economic growth through the next year, UBS said.

Biden's widening lead in polls is already helping stocks, UBS added. Recent weeks' gains temper election uncertainties, and an overwhelming victory would likely reduce the chance that Trump fights the result.

"Investors may have initially feared a Blue Wave, but a delayed or contested election outcome is even more unsettling," the bank said.

Recovery and reflation

With polls increasingly pointing to a Democratic sweep in November, Wall Street is preparing clients to position for such an outcome. UBS expects a blue wave to drive a reflation trade. Increased fiscal relief would provide a shot in the arm for the US economic recovery and lead investors to take on more risk in hopes of greater gains.

Value and cyclical stocks would gap higher after languishing through the virus slump, according to the bank. Sectors still struggling to reach pre-pandemic levels of activity would thrive through the rebound, and investors would shift capital from the growth favorites that saw outsized crowding over the summer.

Continued recovery would also normalize the Treasuries market after months of historically low yields, UBS said. The yield curve would steepen as investors prepare for rising inflation and stronger growth.

Read more: A fund manager beating 90% of his rivals told us why he actively avoids companies with giant profit margins — and shares 5 stocks he thinks will keep winning for years

Goldman Sachs echoed the forecast, saying in a note in late September that a Democratic sweep would increase the chance of a market rotation toward cyclical sectors. Cash parked in mega-cap growth stocks would move into riskier corners of the market as investors bet on a return to pre-pandemic levels of output.

A Biden administration plan for major fiscal expansion would lift profits for growth-sensitive cyclicals and offset headwinds posed by higher taxes, the bank added.

In all, a stimulus boost would add to an "already above-consensus outlook for the US economy," strategists led by David Kostin wrote. A Democratic government would drive a "modestly positive net impact" on corporate profits, the team said. S&P 500 earnings per share could reach $222 by 2024, according to the bank, a 4% increase from a baseline forecast that assumes no change in policy.

Goldman expects the S&P 500 to climb to 3,800 by mid-2021, implying a 7.5% gain from Monday's closing level.

'Dip to buy'

While firms increasingly expect a Democratic sweep to lift cyclicals and drag on growth stocks, Morgan Stanley expects outsized volatility before postelection trends solidify. The broader stock market would initially fall in the event of a blue wave as investors square off against tax-policy uncertainties, the bank said. Emerging-market equities would gap higher, as the stocks avoid such uncertainties and benefit from a greater likelihood of US dollar weakness.

But US stocks represent one of the bank's "detour" trades for a Democratic sweep. A blue wave would drive a short-term deviation from Morgan Stanley's base case, "creating an opportunity to buy a dip or fade a rally," the strategists said in a Friday note.

Read more: Goldman Sachs says buy these 35 stocks for big gains right now as they offer double-digit sales growth and explosive margin expansion

The S&P 500 represents such a "dip to buy" trade, and investors with cash on the sidelines should be ready to hop in at temporarily lower levels, they added.

"We expect fiscal expansion to provide some offset" to higher taxes, the team wrote, "but until the market knows the type of fiscal expansion after a Democratic sweep, expect that equity risk premium could remain elevated into January."

Morgan Stanley's strategists suggest shorting long-dated Treasuries and buying West Texas Intermediate crude futures, as "straightaway" trades are unlikely to change depending on the election's outcome.

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