Why the market narrative on a November ‘blue wave’ flipped in just 2 weeks and what it means for stocks, according to UBS

Joe Biden wearing a suit and tie: Joe Biden, the Democratic presidential nominee. Getty

© Getty
Joe Biden, the Democratic presidential nominee. Getty

  • The market narrative on what a “blue wave” in November could mean for stocks has flipped over the past two weeks, UBS said in a note on Monday.
  • The prevailing market narrative over the past few months that election victories for Democrats would hurt stocks because of the potential for higher taxes is now dead, according to UBS.
  • Instead, expect stocks to move higher if there’s a blue wave, and don’t be surprised if investors are disappointed if it doesn’t happen, UBS said.
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Throughout 2020, the consensus view has been that a Joe Biden victory and a “blue wave” in November would be bad for the stock market because of the potential for higher corporate taxes and more regulation.


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But that market narrative has been flipped on its head in the past two weeks, UBS said in a note on Monday.

Now investors expect that a Biden victory and Democratic sweep in Congress could be a catalyst for a reflation trade, in which cyclical and value stocks trade higher and the US dollar weakens, further helping US stock prices.

The impetus for a change of heart among investors is threefold, according to UBS:

  1. “The inability to pass a major fiscal package prior to the election means that it’s increasingly likely to be the Democrats’ top priority after a Blue Wave outcome.”
  2. Higher taxes will be a 2022 problem for investors, not a 2021 problem.
  3. “Biden’s widening lead in the polls and prediction markets, and along with it the likelihood of a Blue Wave, is reducing election uncertainty,” UBS said, adding that a delayed or contested election would be more unsettling to investors than a Democratic sweep of the White House and Congress.

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This helps explain why stocks have been moving the way they have over the past month, UBS said.

As the probability of a blue wave rose and that of a preelection fiscal stimulus deal fell, small- and large-cap value stocks surged, outperforming large-cap growth by a sizable margin. On top of that, the Treasury yield curve steepened by 11 basis points, while commodities jumped and the US dollar fell.

“In short, it’s the reflation trade,” UBS said.

Expect these trends to last over the next six to nine months, UBS said. But if too much optimism is priced in too soon, it could lead to a “perverse situation in which investors are disappointed if a Blue Wave doesn’t happen,” it said.

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Still, the reflation trade has more room to run, and not just because of the November election, according to UBS.

“The most important catalyst for the [reflation] trade has nothing to do with the election, because it’s a vaccine,” UBS said, adding that early indications that the US could reach COVID-19 herd-immunity levels by mid-2021 were “fairly promising.”

Expect the stock market to price in the economic benefits of herd immunity far sooner than it actually happening, UBS concluded.

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