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Here’s why the Georgia runoff elections for the U.S. Senate could turn into a ‘big deal’ for markets

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The runoff elections for two U.S. Senate seats in Georgia next Tuesday have the potential to inject volatility into a high-flying stock market that has mostly looked past political turbulence in Washington this year.

Market participants say any complacency among investors could be misplaced, since if the Democrats win both senate seats, then the incoming administration of President-elect Joe Biden would have control of both chambers of Congress and may move to reverse the corporate tax cuts of 2017, putting company earnings and stock prices under some pressure.

However, a Democratic victory could also boost equities by raising expectations for more aggressive fiscal stimulus measures next year, on top of the billions of dollars deployed already by Congress.

These are reasons why the Georgia runoff elections could turn into a “big deal” for Wall Street, Michael Reynolds, investment strategy officer at Glenmede, said in an interview.

“If we get a shot in the arm with a larger fiscal package, you need to balance that out with the specter of increasing corporate tax rates,” said Reynolds.

Most analysts are forecasting a victory for the incumbent Republican senators from Georgia, and Betting market PredictIt gives Republicans a 65% chance of staying in charge of the Senate as of Thursday.

But Democratic challenger Rev. Raphael Warnock leads Republican incumbent Sen. Kelly Perdue by 1.8 percentage points in a RealClearPolitics moving average of polls for one of the Georgia runoffs. And in RCP’s average of surveys for the other Georgia contest, Democrat Jon Ossoff is ahead of GOP Sen. David Perdue by 0.8 percentage point. 

Read: Betting markets see Republican win in Georgia’s crucial runoffs, while polls give edge to Democrats

See: Trump plans to campaign on Monday in Georgia county with low early voter turnout

So the outcome of the Jan. 5 run offs could generate volatility in a frothy stock market that many investors see as having baked in most of the good news, including a coronavirus vaccine rollout, more fiscal stimulus, and further economic recovery in 2021.

In particular, the risk of higher tax rates for corporations could upset investors’ pent-up expectations for a rebound in earnings growth next year.

According to FactSet data, earnings for S&P 500 index firms
SPX,
+0.64%

are forecast to surge by 22.1% next year, after falling 13.6% in 2020, which would mark the largest year-over-year earnings jump in a decade.

“We can’t book those earnings expectations right now. They shouldn’t be taken as gospel,” said Reynolds.

But others are more skeptical about whether the Senate election runoffs have the potential to generate volatility in the stock market.

They argue even if Democrats achieve a slim majority in the Senate, a Biden administration may still struggle to push forward with more ambitious items on the policy agenda.

Indeed, to cobble together the necessary votes to raise levies on businesses could prove a difficult task, much more so than passing a new fiscal relief package, said Nomura chief economist Lewis Alexander, who anticipated the corporate tax rate would stay at 21%.

It’s why some feel the recent market quiescence running into next week’s runoff elections reflected how investors were expecting few legislative surprises even if Democrats won both Senate seats in Georgia.

The Dow Jones Industrial Average
DJIA,
+0.65%

gained more than 6% this year, while the S&P500 index
SPX,
+0.64%

finished up more than 15% and the Nasdaq Composite
COMP,
+0.14%

gained 43%.

“It’s hard to imagine moderate Democrats siding with progressives to change filibuster rules or stack the Supreme Court,” Michael Arone, chief strategist of State Street Global Advisors, told MarketWatch.

Looking ahead, investors will face a busy economic docket in the first week of the new year. ISM manufacturing and services gauges for December, weekly jobless benefit claims, November trade deficit, and most importantly, the official employment report for December will be released next week.

Few companies are set to announce their earnings in the coming week Still, Micron Technology
MU,
+4.53%
,
Walgreens Boot Alliance
WBA,
+1.37%
,
Constellation Brands
STZ,
+0.38%
,
Bed, Bath and Beyond
BBBY,
-4.77%

are among the smattering of companies that will report results.

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