Raphael Warnock won the Senate election in Georgia. (Photo: Bloomberg) Raphael Warnock won the Senate election in Georgia. (Photo: Bloomberg)

Despite all the talk about how financial markets prefer a divided U.S. government to a unified one, U.S. stock markets rallied sharply Wednesday after it appeared that the two Georgia Senate runoff elections will result in a Democratic Senate and therefore a unified Democratic federal government. 

Only one of the two races were decided by midday Wednesday — the Rev. Raphael Warnock, a Democrat, beat Kelly Loeffler, the Republican incumbent. But Democratic challenger, Jon Ossoff, was expected to unseat Sen. David Perdue, given his lead in votes and remaining votes still to be counted from primarily Democratic counties.

By 2 p.m. ET, the Dow Jones Industrial Average was up 610 points, or 2%, to just over 31,000; the S&P 500 gained 1.4%; and the Nasdaq, which had fallen in earlier trading, had rised 0.6%.

At the end of the trading day, the Dow closed up 438 points, or 1.4%, at 30,829; the S&P rose 0.6%; and the Nasdaq fell 0.6%.

Among the big gainers were financial stocks, which gained as the yield curve steepened and the 10-year Treasury note yield broke above 1% for the first time since March. Bank of America, Citigroup and Morgan Stanley all soared roughly 6%. 

Solar stocks, such as SunPower and Array Technologies, also surged on expectations that a Democratic Congress and president will adopt policies that fight climate change, boosting alternative energy equities as well as environmental, social and governance strategies.

Mohamed El-Erian, the former co-CEO of Pimco, now chief economic advisor at Pimco’s parent Allianz and president of Queens’ College at the University of Cambridge, tweeted about the importance of keeping “an eye on developments in the U.S. Treasury market where the 10-year yield is now trading above 1.00% and yield curves are continuing to steepen,” referring to the widening spread between two-year and 30-year Treasurys.

Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., told CNBC Wednesday morning that the steeper yield curve is helping financial stocks but that this trade had kicked in after Biden’s presidential win. It gained momentum in December after the Federal Reserve announced that the country’s largest banks could resume stock buybacks in the first quarter of 2021.

She noted that the new administration and Democratic Congress is not a blue wave but a “centrist wave” where moderate Democrats will hold the key to power in a 50/50 Democratic/Republican split Senate, making major tax proposals less likely.

UBS strategists agree. “Although the Democrats may control all three wings of government, a razor-thin margin of control in the Senate and narrow House majority will put more emphasis on centrist policies,” wrote the strategists, led by Mark Haefele, chief investment officer of global wealth management, in Wednesday’s U.S. note.

“A U.S. tax increase is more certain today that it was yesterday … [but]  any tax hike is likely to be smaller than the potential spending increase and might not take effect until 2022,” they continued.

Overall, UBS strategists have a positive longer-term outlook for U.S. stocks in general and for cyclicals in particular based on expectations that the economic recovery will accelerate in the second quarter.

Maybe Wall Street prefers a centrist federal government rather than a split one where little gets done while a pandemic rages and the global economy suffers.

“As the new Covid variant dampens more short-term global economic prospects, policymakers need to pay even more attention to these three key developments — this as the Main Street — Wall Street disconnect persists,” tweeted El-Erian.

He was referring to a Financial Times article that warned about the “unusually large dispersion in performance in big economies, a significant worsening in inequality and deeper economic scarring in the global economy.”