How will the sector rotation in the U.S. stock market proceed after the election? JPMorgan Chase has provided four possible outcomes

Can the U.S. stock market bull run navigate through the election fog? JPMorgan Chase stated that the crowding of market momentum, sensitivity across sectors, and macroeconomic factors will be key determinants of stock market performance in the final months of 2024.

Currently, the U.S. stock market is showing strong momentum, with the S&P 500 index rising 12.5% in three months, marking the strongest pre-election increase in nearly a century.

JPMorgan Chase's report indicated that although uncertainty may ease after the election, the stock market could see upward movement, but the complexity of market dynamics remains significant, especially with increased crowding in high-growth sectors and the impact of upcoming U.S. policy shifts.

JPMorgan Chase conducted a detailed analysis of four key election outcomes: a red sweep (Trump and the Republican Party winning), a blue sweep (Harris and the Democratic Party winning), a red split, and a blue split. Each scenario has different economic and market implications, reflecting the significant policy differences between the Republican and Democratic parties on issues ranging from energy independence to corporate taxation.

Red Sweep: Positive for sectors like energy, banking, industrials, and transportation

JPMorgan Chase stated that a red sweep is viewed as the most favorable outcome for the market, expecting that a red sweep will introduce positive policies, tax cuts, and deregulation in key sectors such as energy, banking, industrials, and transportation.

Specifically:

• Energy: Energy remains one of the most sensitive sectors for the Republican Party, with a strong correlation to Republican outcomes at 32%. Under a red sweep, JPMorgan Chase expects the sector to benefit from relaxed restrictions on fossil fuel exploration, drilling, and pipeline permitting. Analysts believe this could lead to a significant increase in domestic oil production, potentially supporting job growth in the sector, but could also cause price volatility if supply exceeds demand.
• Insurance: The correlation of insurance to Republican outcomes is 27%, primarily due to the industry's exposure to regulatory changes. An agenda emphasizing reduced regulation could enhance the flexibility of insurance companies, particularly regional players, potentially improving profitability. Additionally, as growth accelerates, tax cuts and incentives for small businesses may increase demand for commercial insurance, indirectly benefiting the insurance sector.
• Capital Goods: This group includes industrial equipment and machinery manufacturers, showing a 22% sensitivity to Republican-led policies. JPMorgan Chase believes capital goods companies are well-positioned to benefit from increased infrastructure spending, a focus on U.S. manufacturing, and favorable trade policies that protect U.S. industries. The sector also benefits from tax incentives encouraging capital investment, which could accelerate growth within a deregulation framework.
• Durable Goods and Apparel: With a Republican sensitivity of 19%, durable goods and apparel may see the removal of import tariffs and changes in trade policies protecting U.S. manufacturing. This sector encompasses everything from automobiles to household goods, which are typically affected by global supply chain dependencies. A Republican-led government may impose tariffs to reduce foreign competition, thereby benefiting domestic manufacturersHowever, JPMorgan Chase warned that input costs may rise due to tariffs on raw materials such as steel and aluminum.

For the Federal Reserve, a red sweep could lead to a delicate balance between economic resilience and inflationary pressures, which may result in a further steepening of the U.S. Treasury yield curve. JPMorgan's interest rate team expects that, driven by anticipated fiscal expansion, the 10-year U.S. Treasury yield could rise by 30-40 basis points.

On the other hand, JPMorgan believes that industries with significant risk exposure in global trade, such as technology and communications, would suffer losses in a red sweep scenario.

Notably, JPMorgan warned that momentum trading, especially in large tech and semiconductor stocks, is currently very crowded, having reached the 99th percentile three times over the past year.

This extreme crowding represents market fragility, where any sudden policy or macroeconomic shift could trigger violent rotations in stocks within that sector. The report stated that a red sweep could lead investors to shift from overvalued growth stocks to value stocks and domestic equities. If the Federal Reserve continues to maintain loose monetary policy, this shift could be amplified.

Blue Sweep: Likely Less Favorable for the Stock Market

JPMorgan believes that a blue sweep may be less favorable for the stock market, as Democrats are expected to prioritize fiscal measures targeting green energy, healthcare reform, and potential increases in corporate taxes.

This could sustain momentum in industries related to green initiatives and U.S. manufacturing while putting additional pressure on multinational companies that rely on global supply chains and tax incentives.

Specifically:

• Software: Under a "blue sweep," the software industry may benefit from policies favorable to digital infrastructure, cybersecurity, and technological innovation. The Democrats' focus on expanding broadband access, supporting government-funded digital transformation, and encouraging cybersecurity initiatives could boost demand for software services and platforms across various sectors. This industry includes companies involved in cloud computing, enterprise software, and security software, all of which are expected to benefit from federal support for a technology-forward agenda.
• Semiconductors: Semiconductor companies are a key component of the U.S. tech industry and are expected to benefit from ongoing support for the CHIPS Act and efforts to strengthen domestic chip production.
• IRA Green/Electric Vehicles/Climate: Under a Democrat-led government, green energy stocks (including those related to electric vehicles and renewable energy) will receive substantial support, aligning with their ambitious climate goals. Expanding tax credits, direct subsidies, and regulatory support for clean energy projects could boost companies in the solar, wind, battery storage, and electric vehicle supply chains.
• Healthcare Reform Beneficiaries: As Democrats prioritize healthcare reform, including expanding Affordable Care Act subsidies and measures to lower prescription drug prices, healthcare services and managed care providers may benefit.
• Child Tax Credit Beneficiaries: Companies in consumer goods, retail, and education-related industries may see increased demand associated with the expansion of child tax credits and social welfare programs, which will enhance household consumption capacity, especially among low- and middle-income families.Analysts indicate that a blue sweep will promote the continued strengthening of the dollar, tighten liquidity, and squeeze companies reliant on exports.

Divided Government (Red or Blue):

While a divided government scenario may continue the current policy trajectory, JPMorgan Chase points out that the outcome of a red division will provide some upside potential, particularly for industries sensitive to tax cuts and deregulation.

In contrast, a blue divided government could support industries aligned with environmental and healthcare reforms, such as clean energy and pharmaceuticals.

This chart shows the performance of the S&P 500 index during U.S. presidential terms. From the chart, it can be seen that the S&P 500 index has shown a long-term upward trend, regardless of whether the Democrats or Republicans are in power.