How will Wall Street fare under a divided US government next year? Midcap, US tech stocks in focus

The coming year will see a divided government in the United States. The Democrats will control the Oval Office and the House of Representatives, while the Republicans will hold the Senate. This will result in a sea of change from what had been happening for the last four years. The impact will be seen in the stimulus package, regulations and hence on Wall Street. However, the split government will also help in curbing any move to significantly increase taxes, aggressive regulations on healthcare and fossil fuel, according to global investment bank UBS.

Divided house

A divided government is likely to have three key effects in UBS’ view. First will be an aid package that UBS estimates could worth anywhere between $500 billion and $1 trillion, or roughly 2.5-5% of GDP. This “should bode well for consumer spending and business confidence, and help drive a shift in market leadership away from large-caps and toward mid-caps,” said UBS in the report. They believe midcap earnings are more leveraged to an economic recovery, helping them grow twice the pace of large caps.

Further, the additional fiscal spending that the new administration is expected to undertake, UBS believes, will be funded by a rising deficit and not by additional taxes. This will widen the current account deficit and weaken the US dollar. The incoming administration of President-elect Joe Biden is expected to renew the US foreign policy approach which will result in improved relations with Europe. “Although the fundamental US-China geostrategic rivalry won’t change, we do think the new administration will be less likely to use tariffs as a tool of foreign policy,” UBS said. Such a move reinforcing preference for cyclicals such as industrials.

Will FAANG fade out?

The outperformers of this year — the US technology stocks — might continue to perform well in 2020 but valuations continue to be expensive. “We expect the technology sector to continue to benefit from strong secular growth in digital advertising, e-commerce, cloud computing, and the 5G rollout,” UBS said. So far in 2020, Facebook shares have gained 30%, Apple stocks have zoomed 58%, and Amazon has gained 64%. Netflix the OTT content platform has seen a 49% rise in stock value this year while the internet giant Google has surged 29%.

With increased valuations it is fair to believe that other segments of the market will play catchup in 2021 as recovery gains pace. On the other hand the Antitrust case could be an overhang. However, UBS believes that a divided government would reduce the probability of new regulations, while adding that they expect judicial proceedings to take years to reach a resolution.