A Joe Biden win and GOP holding the Senate could be a nightmare scenario for stocks

New York(CNN Business) The stock market surge since March has taken place even as Joe Biden has built a lead against President Donald Trump in many polls. That has led some to suggest that Wall Street would not panic if Biden is elected.

But dig deeper and it's a bit more nuanced than that. A Biden defeat of Trump may not necessarily upset investors. But the top economist at asset management firm AllianceBernstein worries that a Biden win coupled with the Republicans holding onto the Senate could be bad news for stocks.

Biden in the White House and the GOP maintaining control of the Senate could lead to the worst kind of gridlock. Republicans may play even more hardball with regards to new stimulus -- at a time when more money needs to be spent by Washington to help consumers and small businesses that have been hit hard economically by the Covid-19 pandemic, noted Eric Winograd, a senior economist at AB, in a recent blog post. (Winograd, like most political pundits, assumes that the Democrats maintain control of the House.)

The possibility of more austere federal budgets could kill the nascent recovery for the economy and stocks.

"A Democratic president and Republican Senate could be more problematic for markets," Winograd wrote. "The Senate is already reluctant to roll out more stimulus—and would very likely prevent more stimulus spending altogether if the White House changes hands."

"Because the US economy and financial markets rely a lot on that spending, the risks of a double-dip recession would be very high, and financial markets very likely would suffer," Winograd added.

Winograd argues that if Democrats take the Senate but Trump is re-elected, there may be "a more benign version" of gridlock.

In other words, Winograd thinks the Senate may play hardball with the Trump White House but "over time, we expect a spending agreement in this scenario...after a slow and painful process."

And in the case of either a red wave (the status quo with Trump and Senate retaining control) or a blue wave (Biden and Democrat majority in Senate), Winograd thinks that Congress would increase the government's spending.

Winograd concedes that a rollback of Trump tax cuts under Democrats could be problematic in the near-term for stocks, but increased infrastructure spending in a Biden presidency could offset that.

Bucking conventional wisdom

Some investors believe that the most ideal outcome for the market would be if there is a convincing win for either party. In other words, the market does NOT want gridlock.

According to a Hartford Funds survey of nearly 1,000 investors conducted last month, 46% said a GOP-controlled White House and Senate would be best for the markets.

Brian Kraus, head of investment consulting at Hartford Funds, said 32% of those polled felt that the markets would fare best if Biden won and the Democrats took the Senate. Only 22% felt that a division between the two parties would be best for stocks.

Kraus says that goes against both conventional wisdom -- and historical data -- which show the market is happiest when the two parties are bickering and little gets done.

Still, it's not that simple. Dec Mullarkey, managing director of investment strategy with SLC Management, said that a divided government might also mean that there is a chance for more compromise.

"The markets unequivocally like a mixed government because they are more comfortable with less overreach and more negotiations," Mullarkey said.

The good news for Wall Street is that many experts believe either Trump or Biden would be inclined to reappoint Federal Reserve chair Jerome Powell to a second term, a move that could provide much needed stability for investors.

Don't fear the blue wave

Gregory Staples, head of fixed income at DWS, added that investor fears of a blue wave, which he puts at about a 35% to 40% likelihood, may be overblown as well.

Staples thinks that Biden would recognize that enacting many of the policies espoused by the more progressive wing of the Democratic party would do more harm than good and that negotiation will be key.

"There will be a need to do things like raise corporate taxes but he will want to be cautious," Staples said. "Raising tax rates from 21% to 28% for example would only have a small impact on corporate profits for large cap companies."

"It would be political suicide if the stock market tanked under Biden." he added.

Mullarkey said Biden may not be as much of a hardliner as Trump with regards to trade agreements. That would be something that many investors would cheer, especially since the multinationals that dominate the S&P 500 do a lot of business with China and Europe.

But Hartford's Kraus suggested that investors may simply be craving certainty in a time of political instability. That's possibly the reason why investors are hopeful that there is a more clear mandate after the election -- regardless of whether it's for Biden or Trump.

He said the biggest risk for this particular election isn't necessarily who wins -- but the possibility that the results are contested.