A Wall Street expert warns the stock market would drop 10-15% if the Georgia run-off turns the Senate blue — and says investors should look to these 4 areas if it does
- Democrats will control the Senate with Vice President-elect Kamala Harris as the tie-breaking vote if their two candidates win the Senate runoff races in Georgia.
- If Democrats effectively secure the executive and legislative branches, the stock market would fall by 10-15% as investors anticipate higher capital-gains tax rates, says Brian Walsh of Walsh and Nicholson Financial Group.
- Walsh pointed to four areas of the market where investors might consider putting their money in this scenario.
- Visit Business Insider's homepage for more stories.
As the presidential election results came in, investors seemed to contradict themselves.
In the weeks leading up to Nov. 3, many on Wall Street were saying a Democratic sweep of the presidency and Congress would hurt markets due to the potential for tax increases. Others viewed it as the best outcome because it promised to deliver the most robust stimulus package for the economic recovery.
Then when it looked as if Biden would become president with a split Congress — what some viewed as the worst possible outcome in terms of getting a sufficient second stimulus deal done — investors became giddy, driving the major indexes higher on consecutive days.
Although a larger stimulus package may have been off the table, so were the higher corporate taxes and regulation preferred by Democrats.
The prospect of a Democratic sweep is now back on the table with President-elect Joe Biden's victory due to be certified by Congress and as the two Senate seats in Georgia head to a runoff this week.
Neither Republican Kelly Loeffler nor Democrat Raphael Warnock came close to the required 50% majority needed to win. In the state's other race, Republican David Perdue and Democrat opponent Jon Ossoff also met the requirements for a runoff.
If both Ossoff and Warnock win in that runoff, Democrats would control the Senate with Vice President-elect Kamala Harris being the tie-breaking vote for what would be a 50-50 party split in Congress' upper chamber.
"This Senate race being as close as it is and potentially flipping seems to be very surprising and I think you're seeing that being reflected in the markets today a little bit," said Brian Walsh, senior financial advisor at Walsh & Nicholson Financial Group, in a Nov. 6 phone interview. The firm has about $900 million in assets under management.
Walsh said that because the expected outcome flip-flopped, a double Democratic win in Georgia would send the market into a shorter-term spiral.
"It's something that could last 3-6 months I think," he said. "Not necessarily a recessionary event, but definitely a corrective event with a 10-15% drawdown if we do have a blue wave come through, simply because of all the tech gains that are going to have be taken off the table for capital gains tax purposes, especially with Biden's tax policy being to increase capital gains tax rates."
Others on Wall Street are also warning that the runoffs poses a hurdle for investors in the near-term. Oppenheimer's Chief Investment Strategist John Stoltzfus, for example, said in a Monday note that the S&P 500 would drop 6-10% if Democrats win both races.
Still, Walsh said a Democratic sweep would not hurt markets long-term, citing the outperformance of stocks under Democrat-controlled governments compared to Republicans since 1932.
It's a line of thought that others on Wall Street agree with.
"Even if the Democrats even the Senate at 50/50, moderate Democrats may limit what can get done," Jeff Buchbinder, an equity strategist at LPL Financial, said in a statement to Business Insider.
"Also consider that stocks have historically done very well under Democratic sweep scenarios, with the S&P 500 up 15 of the 18 years and up an average of 13% (since 1950)," Buchbinder added.
4 places to put your money if Democrats take the Senate
Walsh said a divided-government outcome — which he believes is most likely and is therefore positioning his clients for accordingly — is the best-case scenario for markets.
"It is status-quo. You're not going to have any aggressive fiscal policies come through, which is a positive for the equity markets, and you're going to have lower taxes, which is a positive for the equity markets and corporations profits," he said.
But if Congress does indeed fall under Democratic control, which he believes is the worst-case scenario in the short-term, he laid out three areas of the market investors ought to look to.
Overall, he said investors could begin rotating out of growth stocks and into more cyclical stocks, which would benefit from heftier fiscal stimulus.
More specifically, he said to keep an eye on utilities.
"Utilities right now are kind of a value play," Walsh said. "If we have a blue wave, growth will be put on hold, I think we're going to see that materialize into further gains in the utilities sector."
Investors seeking exposure to the utilities sector might consider a utilities-specific exchange-traded fund like the iShares U.S. Utilities ETF (IDU).
Other areas Walsh likes in the case of a Democratic sweep are industrials and materials, with the high likelihood of an infrastructure plan being passed.
"I think industrials and materials would be a pretty good play given the fact that the Biden campaign does want to have a massive infrastructure movement," he said. "If we do get this flipped Senate, you're going to see some of those policies come to fruition."
The Vanguard Industrials ETF (VIS) offers broad exposure to the industrials sector, and the Materials Select Sector SPDR ETF (XLB) offers exposure to the materials sector.
Finally, Walsh said stocks placing an emphasis on environmental, social, and governance standards, or ESG, could benefit.
"You might see a big influx into ESG as more regulation comes into play and climate change policies are put on the table by the Democrats," he said.
The iShares ESG MSCI USA Leaders ETF (SUSL) offers broader exposure to ESG-focused stocks.
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