MORGAN STANLEY: A 'blue sweep' could pressure key parts of the stock market - here's how to protect your portfolio
- Morgan Stanley's policy strategists flagged to clients several polls that showed the rising odds of Democrats recapturing a Senate majority in the midterm elections.
- They don't expect this outcome, but have still offered some recommendations for investors who want to hedge.
- The market implications of the midterm elections revolve around fiscal policy.
If the polls are on the money, Democrats are poised to regain a majority in the House, but not the Senate, in the November midterm elections.
They'd need to flip 24 Republican seats in the House. But the two seats they'd need to replicate this in the Senate are likely to remain red, or Republican, polls show.
Policy strategists at Morgan Stanley agree.
"'Blue House' (Democrats gain control of the House but not the Senate) remains the most likely outcome," said Michael Zezas, the chief US policy strategist at Morgan Stanley, in a note to clients on Thursday.
However, the strategists also saw evidence, including polls from FiveThirtyEight and PredictWise, that showed the rising odds of Democrats achieving a so-called blue sweep. And so, they examined how investors can start preparing for what would the unexpected result.
Zezas said investors should be ready for pressure in key sectors of the stock market like pharma, telecom (which was folded into the new communication services sector on Friday), and healthcare services.
It's a sentiment that's shared by analysts over at UBS, who said in a recent note that a blue wave could be detrimental to risk assets.
"If Democrats move to impeach President Trump in the House without Republican support, there could be a short-term sell-off in risk assets," Mike Ryan, the chief investment officer at UBS, said. "However, given the high probability of acquittal in the Senate, there will likely be little to no lasting market impact."
Should the majority in Congress change, Democrats could make bigger pushes for more price controls on prescription drugs, and enact more regulations on telecoms and healthcare companies, Zezas said.
"A Blue Sweep would be a powerful piece of evidence that the US electorate is more willing to embrace more progressive policies should Democrats' success extend to the presidential election in 2020," he said.
The further implications of the midterm outcome revolve around fiscal policy, arguably Republicans' biggest legislative accomplishment since 2016.
Should they lose, Zezas sees Republicans returning to their traditionally conservative stance on government deficits, and pressuring Democrats to control spending on discretionary programs.
Also, even if Democrats win both chambers of Congress, they would still not have 60 votes in the Senate and would need to use reconciliation to pass infrastructure bills, limiting their efficacy.
Still, Zezas suggested two things investors can do if they have a blue sweep in their purview:
- Add Treasury duration and curve flatteners. A blue sweep "all but eliminates" the possibility that the next Congress will pass a second iteration of the Tax Cuts and Jobs Act, according to Zezas. Also investors may think that some existing provisions could be rolled back or allowed to expire in the medium term. "We recommend 2s10s and 2s30s UST curve flatteners and being long 10y and 30y outright," Zezas said.
- Add emerging-market risk. Some of the underperformance this year has been attributed to the trade war, and a blue sweep could hint to investors that de-escalation is possible. If markets price in this possibility, it would pay off to already be invested ahead of time.
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