Why the stock market is loving the prospect of a divided government

• Stocks are rallying the most in months even though the US presidential race is still up in the air.
• That's because the most important election outcome has already emerged.
• A Republican-controlled Senate could block tax hikes and regulations sought by Democrats.
• Senate Majority Leader Mitch McConnell said Wednesday that he aimed to pass a smaller stimulus bill before the new year.
• Visit Business Insider's homepage for more stories.

For stock investors, the most important US election outcome has already materialized.

Wall Street banks and pollsters alike largely expected a blue wave on Election Day. A Democratic-controlled government would be likely to pass massive fiscal stimulus early next year to reinvigorate the nation's economic recovery.

But that didn't happen, with Republicans winning several key Senate seats. Though some races are too early to call, it's unlikely that Democrats will pull off the congressional sweep they hoped for.

Instead of lamenting the death of a frontloaded stimulus deal, investors found new reasons to be bullish. Traders had been preparing for a Democratic-controlled government to raise corporate taxes and regulate major industries, policies that would likely cut into corporate earnings. If Republicans maintain control of the Senate, they're poised to block such efforts.

It's also "hard to imagine" that Senate Majority Leader Mitch McConnell will reverse the Trump administration's tax cuts, Ralph Schlosstein, a co-CEO of Evercore, said on Wednesday. The lower rates boosted corporate profits and helped to fuel the longest-ever bull market.

Read more: 3 veteran investors share where to invest now to build resilient, long-term portfolios that win even if the elections produce a gridlocked government

That newfound optimism helped fuel the S&P 500's largest one-day gain since June on Wednesday, when healthcare and tech giants surged as the specter of regulation led by Democrats faded. The rally extended into Thursday, with the same growth favorites pushing major indexes higher.

The legislative gridlock set to emerge in the 117th Congress wouldn't just help those fearing higher taxes and stricter regulation. McConnell on Wednesday opened the door to another relief package, saying new aid should be passed before the end of the year. He also hinted that he would support additional aid for state and local governments, a sticking point between the parties that hampered talks before the election.

"Hopefully the partisan passions that prevented us from doing another rescue package will subside with the election," he said.

With new daily coronavirus cases reaching record highs and the pace of economic recovery slowing, negotiations would likely be more urgent. A near-term deal would at least somewhat appease those hoping for a blue wave to yield fresh stimulus.

Read more: Warren Buffett's Berkshire Hathaway swung from extreme caution to a flurry of deals in 6 months. We asked a bunch of experts to analyze its shifting strategy

Whether investors hope for Joe Biden to hold his lead or fall behind President Donald Trump in the lengthy vote-counting process, they can rest assured that "the most controversial policy initiatives of either party are off the table for at least two years," Steven Ricchiuto, the chief US economist at Mizuho, said Wednesday.

At least for the market's medium-term outlook, the "picture hasn't really changed," Mark Haefele, the chief investment officer at UBS, said on Wednesday. "It's rare that an election matters so much in and of itself for what markets are doing in the global suite of the economy."

Now read more markets coverage from Markets Insider and Business Insider:

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