Two months ago, the market celebrated the likelihood that the Republicans would hold the U.S. Senate and there would be gridlock in Washington. It now looks as though the Democrats will take Georgia's two Senate seats, which will produce a 50-50 split in the Senate and allow Vice President Kamala Harris to break any ties.
The results are not final, but the market is reacting strongly, with the Nasdaq 100 futures trading down about 1.3% about two hours before Tuesday's open while small-caps were indicated up 2.8%. Rotation is the name of the game as market players try to sort out the winners created by this shift in power. Sectors such as solar energy, electric vehicles and cannabis are jumping while big-cap technology and the FATMAAN names struggle. Some sectors will benefit from greater government support while others will suffer due to higher taxes and more government regulations.
The dollar and bonds are weaker as anticipation of increased Democratic spending is viewed as creating inflationary pressures. There is the likelihood of more significant fiscal stimulus in the short term, massive aid to cities and states, and significant infrastructure spending. While that will create some winners in various sectors, it comes with the cost of a larger deficit, higher inflation and an increase in interest rates. It will also increase pressure to raise taxes to pay for the spending.
The greatest fear of Republicans is that the Democrats will push to eliminate the filibuster rule. If that happens, the Democrats will be able to impose their agenda with a simple majority. There is some opposition to this by the likes of Sen. Joe Manchin (D-West Virginia), but this will be a big battle that will determine whether Democratic policies are passed.
The good news for market participants is that this remains a market for stock picking. The small-caps' early strength illustrates that money is flowing into individual names based on fundamental views. Trying to time the major indices is extremely difficult due to all the underlying crosscurrents.
My game plan continues to be the same. I will manage individual positions closely and continue to hunt for new setups. Trying to call a market top is a waste of time when we have this sort of rotational action taking place under the surface.