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Sliding Yields Recharge Stock Rally That Was Betting on Stimulus

Bloomberg logoBloomberg 11/4/2020 Justina Lee

(Bloomberg) -- Stock traders who once counted on a fiscal splurge under a Blue Wave Congress have kept their mojo thanks to a time-tested driver of the bull market: Cheap money.

As Treasuries surged, investing strategies riding near-zero interest rates got another shot in the arm -- helping money managers look past their dashed hopes for a massive stimulus under a unified Democratic government.

With U.S. stocks jumping as the ongoing vote count pointed to a Joe Biden win under a Republican Senate, market pundits were quick to tout the positive case for equities. A stimulus package -- albeit a smaller one -- is still likely, while the Federal Reserve is iron-clad in its resolve to pin down rates.

Among the winners for the renewed low-for-longer regime: Large-cap companies over small, growth stocks over value, America over the rest of the world. In sum, it’s game on for a rally long seen as divorced from Main Street.

chart: Lower real yields could be good news for equities © Bloomberg Lower real yields could be good news for equities

“Less stimulus means lower U.S. Treasury yields, lower inflation expectations and an increased burden on the Fed to offset economic damage from the current Covid surge,” Evercore ISI strategists led by Dennis DeBusschere wrote in a note. “As a result, bond volatility is likely to move significantly lower, which will bias the VIX lower and support equities.”

As inflation expectations dropped on Wednesday, real yields fell, helping strategies linked to growth and momentum stocks. The drop in long-term borrowing costs is good for shares such as Big Tech that are attractive for their long-term growth, since it means future cash flows can be discounted at lower rates. Conversely, all that bodes ill for value stocks that had gained a bit of traction lately on expectations for a Blue Wave.

The return to tech leadership is also likely to benefit hedge funds, which tend to be overweight the sector, according to a note from Credit Suisse Group AG’s prime risk advisory team. Wednesday’s market moves lifted the outperformance of popular bullish bets among such clients, it said.

chart: The equity momentum trade has become tied to rates © Bloomberg The equity momentum trade has become tied to rates

Meanwhile, the Russell 2000 Index of small-caps were set for their worst day versus the S&P 500 since April. Emerging-market shares headed for their biggest underperformance against U.S. stocks -- which benefit from having more growth exposure -- in more than a month.

Read more: Reflation Is First Casualty as Big Fiscal Stimulus Bet Unravels

Before the election, many investors had counted on a Democratic sweep to reverse these long-term trends in the equity market, especially since valuation gaps between the winners and losers had already widened to the most in years.

Instead, political gridlock is likely to bring more of the same, at least for now.

chart: U.S. stocks have been outperforming for a decade now © Bloomberg U.S. stocks have been outperforming for a decade now

“It is one of the calmest in terms of market shifts,” Morgan Stanley strategists Andrew Sheets and Serena Tang wrote in a note. “Scenarios with less fiscal stimulus are more likely than 24 hours ago, and that reduces the probability of larger, more extreme market rotations, rotations that we do not believe investors were positioned for.”

Even with the result still undecided, traders appear unfazed. In stocks, the Cboe Volatility Index dropped the most since March and bets on higher short-term swings in bonds also faded.

Read more: Doomsday Market Predictions Give Way to Never-Ending Rally (1)

All in all, between expectations for rates to stay low for longer and some sort of fiscal stimulus eventually, risk sentiment appears sound. History is generally also on the side of staying put. As stocks rise over the long-term, performance has been similarly positive in both years of a split Congress and of unified government, according to an analysis from Capital Group published before this year’s vote.

chart, bar chart © Capital Group

And then there is always the Fed put.

“Fed intervention, and future fiscal stimulus (albeit slower and smaller than would be the case for either party’s clean sweep) should provide a modest upside to U.S. equities,” Mizuho International strategists Peter Chatwell and Henry Occleston wrote in a note.

(Updates with context, links, touts.)

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