Bernie Sanders winning the White House would be Wall Street's worst political nightmare.
Investors famously hate uncertainty. And it's hard to imagine something that would cause more uncertainty to the capitalist system than electing a self-proclaimed democratic socialist who is calling for a political revolution. Sanders wants to ban oil and gas fracking, break up big banks and institute a wealth tax.
That's why Wall Street could feel the Bern -- and not in a good way -- if Sanders wins big in the Iowa caucuses on Monday and continues that momentum through Super Tuesday. Investors would be forced to confront the reality that Sanders, once seen as a long-shot candidate, could win the 2020 election.
"Bernie could get off to a very fast start. He has passionate supporters. Markets have dismissed him prematurely," said Greg Valliere, chief US policy strategist at AGF Investments.
Jeff Gundlach, the billionaire investor who correctly predicted Donald Trump's 2016 victory, similarly warned Wall Street last month of a looming Sanders "scare" for markets.
Sanders has surged in the polls throughout January and is now viewed as the odds-on favorite to win the nomination by users on prediction market PredictIt. Sanders now has a 46% chance of winning the nomination, up from 18% in early December. The next closest Democrat is Joe Biden, with 27%, according to PredictIt.
Rewriting the American economy
Love him or hate him, there's no debate that Sanders is embracing policies that would rewrite broad swaths of the American economy. The US Senator from Vermont wants to break up Facebook, curb stock buybacks and provide Medicare for all. Whatever the wisdom of those moves, each would bring about enormous uncertainty for investors.
"Bernie's prescriptions would be disastrous for the markets. He would be viewed with tremendous anxiety by the markets," said Valliere.
By contrast, Sanders's chief rival Biden has advocated less dramatic policies. For instance, Biden supports a carbon tax, but does not want to ban fracking or fossil fuel exports. He wants to expand Obamacare but opposes Medicare for all. Biden is calling for higher corporate taxes but has not rolled out a wealth tax like Sanders.
"I believe the market can live with Joe Biden because he's accepted as more of a centrist," said David Kotok, chairman and chief investment officer of Cumberland Advisors.
Wall Street could also live with other moderates still in the running, including billionaire Michael Bloomberg, former Indiana mayor Pete Buttigieg and Senator Amy Klobuchar.
Bernie vows to be Wall Street's 'worst nightmare'
For his part, Sanders has embraced his casting as Wall Street's boogeyman.
"The billionaire class is scared and they should be scared," Sanders wrote on his Instagram page last month.
Sanders vowed to "end the greed" of various industries, including Wall Street, insurance and fossil fuels.
"We're prepared to be their worst nightmare and stand up for the working families of this country," he wrote.
Of course, it's important to remember that a President Sanders could not wield a magic wand to enact his extreme policy proposals. Congress must approve any sweeping changes. Republicans (as well as perhaps some moderate Democrats) would surely seek to block the Sanders agenda. And the GOP may still control the US Senate.
Even if a progressive wins the White House and the Senate turns blue, there will be enough moderates to "bottle up the most aggressive policy changes," Cowen analyst Jaret Seiberg wrote in a note to clients Monday.
"The Senate would be the firewall," said Valliere.
Bernie's surge could help Trump
Some argue that it's far too early to freak out about Sanders, even if he performs well during the early nominating contests.
"He has just about zero chance of winning a presidential election," Peter Boockvar, chief investment officer at Bleakley Advisory Group, wrote in a note to clients Monday. "The markets instead should assume that Trump gets reelected the better Sanders does, whether you like that or not."
If Sanders is the nightmare outcome, four more years of Trump is widely seen as the best outcome for the stock market and Wall Street.
"A second term of Trump is more low taxation, more deregulation and an indifference about trillion-dollar deficits," said Kotok. "Markets like that. Whether the country likes it, once it's fully digested, is another matter."
But a Trump reelection also brings risks.
"Unbound by the political and electoral constraints...a second-term President Trump could prove even more aggressive and unpredictable in using tariffs," Evan Brown, head of asset allocation strategy at UBS Asset Management, wrote in a January report.
Stocks perform much better under Democrats
David Kelly, chief global strategist at JPMorgan Funds, said that while a corporate tax hike would be negative for stocks, the volatility and uncertainty caused by standoffs with China and Iran have likewise been negatives.
"I don't think we should automatically draw the conclusion that a Republican must be better for the market and a Democrat must be worse," Kelly said. "History doesn't show that."
In fact, since 1944 the S&P 500 has averaged a gain of 11.1% per year under Democratic administrations, compared with 6.9% under Republicans, according to CFRA Research. That trend is even more pronounced immediately after an election. The S&P 500 has averaged a gain of 17% during the first year of a Democratic presidential cycle, compared with just 0.4% under Republicans.
It's also wise to take market predictions related to politics with a grain of salt. No one knows exactly how the market will react to a new sheriff in town. And at the end of the day, the underlying health of the economy and corporate profits, not politics, is the real driver of stock prices.
For example, many on Wall Street warned that a Trump upset victory in 2016 would spell doom for stocks. And they were right -- for about five hours as stock futures plummeted in the immediate aftermath of Trump's win. Stocks then took off on an historic rally and today Trump is viewed as the best-case scenario for Wall Street in 2020.