'Combustible setup': UBS eyes potential for S&P 500 rally after U.S. midterms

U.S. stocks could rebound into year end, supported by favorable seasonal trends and light equity positioning among hedge funds, UBS Securities argues. The investment bank sees scope for a rally after Tuesday’s U.S. midterm elections.

Seasonal trends could help stocks recover from the October selloff, Davide Montoni, Americas head of institutional equity derivatives and quantitative investment strategies sales at UBS Securities, wrote in a note cited by Bloomberg. The broad-market S&P 500 has gained an average of 1.9% in November since 1950, making it historically the strongest month of the year. Low net exposure among hedge funds could amplify a rally, “creating a potentially combustible setup, if the market can clear the final major catalyst of the US Midterms on Tuesday,” Montoni wrote.

“Hyperscaler earnings clearly did not provide the all-clear investors were hoping for, but getting through the election could be the catalyst that unlocks a year-end squeeze,” Montoni wrote, referring to Big Tech’s latest results.

The market remains under pressure. The tech-heavy Nasdaq 100 entered correction territory on Monday, more than 10% below its October peak. Tech stocks staged a modest rebound on Tuesday, with the Nasdaq 100 up 0.6%, the broader Nasdaq Composite up 0.8%, and the S&P 500 up 0.3%. The Dow Jones Industrial Average was the only one of the four indexes in the red, down 0.4%.

The election could shift the balance of power in Congress, with Democrats in a position to wrest control of both the House and the Senate from Republicans. Investors are concerned about uncertainty over future U.S. policy on the AI infrastructure buildout.

A decisive Democratic sweep could weigh on financial stocks and data center operators, Montoni wrote. The S&P 500 financials sector gained around 6% in October, leaving room for a short-term hedge against that outcome. UBS recommends buying put options on the State Street Financial Select Sector SPDR ETF expiring November 20.

Montoni also sees an opportunity in renewable energy stocks, where investor positioning has fallen to around a one-year low. A Democratic victory could give the sector a lift, and light positioning leaves room for investors to rebuild their exposure.

Traders bought December call options last week on the Invesco Solar ETF, which invests in solar energy stocks, according to UBS. The fund was up 3% on Tuesday and remained down more than 11% year to date.