What Georgia’s election means for markets

In 2016, bank stocks skyrocketed, while technology stocks initially declined and then lagged behind the market for months. Political students had an easy explanation: Republicans favor Wall Street, while Silicon Valley is a progressive bastion.

Easy, but wrong, as the Georgia Senate vote showed. The investor’s response to the vote in Georgia (not yet final, but interpreted by forecast markets as a sure thing for Democrats) was to buy banks and sell Big Tech.

Of course, the policy has changed, and Facebook and Amazon are now treated as bad by many on the left. The possibility of higher capital gains taxes is likely to hit stocks that also left investors sitting on large unrealized profits.

But what really matters is something common to 2016 and today: the reflection trade. The idea that the government will borrow and spend more, supporting the economy and bringing higher inflation and therefore less support from the Federal Reserve. This appeared on Wednesday in a big jump in 10-year Treasury yields that took them back above 1% for the first time since March. Another sign was a further increase in inflation expectations, already the biggest since April 2019.

Higher bond yields help banks, just as they did after Trump was elected. They hurt Big Tech, because profits in the distant future are worth less if the safe alternative is more attractive. All FANGs – Facebook, Apple, Netflix and Alphabet (nee Google) – fell, along with many smaller tech stocks.

The rest of the market shared the analysis: cyclical stocks sensitive to the economy outperformed safer defensive stocks in general, with the financial, industrial and discretionary consumer sectors all doing well. The winners outnumbered the losers in the S&P 500 by more than 2-to-1, but Big Tech’s size meant that the index as a whole struggled, rising just over 1% in the late morning. The Russell 2000 index of smaller companies is less dominated by these growth-oriented companies and jumped 3.3%, even as their growth shares declined.

It is important to note where the policy has the most direct effect. Anything related to the environment increases each time the Democrats’ prospects improve, because regulations and subsidies become more likely to favor companies. Senate control makes it easier to appoint agency heads who will push the agenda through regulations, since they cannot be obstructed.

Invesco Solar ETF is an imperfect measure of President-elect Joe Biden’s support because it includes many foreign shares, but has surpassed Georgia’s results, up more than 8%. (Electric car maker Tesla has also risen, but lives off the hopes and dreams of its shareholders and rational explanations may not apply.)

The question is whether this is yet another false dawn for reflection. Investors expected inflation and higher bond yields nearly every year for two decades, and they were almost always wrong. After Trump’s election, he failed to deliver on promises to spend more on infrastructure, rather than focusing on corporate tax cuts. This brought deficits, but little boost to the economy and no increase in inflation. Bank stocks lagged behind the S&P 500 during 2017, while Big Tech stocks and other growth stocks had a highly successful year.

Even assuming the market is right about Democrats winning both seats in Georgia, that does not mean that Biden will be able to turn to the left. Each Democratic senator is required to approve anything that Republicans reject, which means that each has a veto right – and centrist senators are sure to block anything they consider going too far, including much of the spending on the New Green Deal. proclaimed by the left of the party.

So far, the scale of the movements shows that the market is not charging Biden much. A significant extra stimulus would likely increase the recovery of cyclical stocks, while Big Tech would likely be left out.

But investors have learned a lesson from the past decade: when there is nothing specific to boost bond yields, cheap, cyclical stocks, buy bonds and buy Big Tech. Both are expensive, but if Mr. Biden doesn’t deliver, they can easily get even more expensive.

Write to James Mackintosh at James.Mackintosh@wsj.com