It’s generally accepted that investors like certainty. They can adapt to any environment but doing so can be both disruptive and expensive. As investors have ‘skin in the game’ in that they can realise profits or losses very quickly following a big event, it’s very useful to ‘follow the money’ when trying to predict the outcome of what is essentially a binary event, such as this presidential election.
A look-back at previous elections shows that stock market strength ahead of election day tends to signal victory for the incumbent. The performance of the S&P 500 in the three months preceding Election Day has been 87% accurate in predicting the winner. Looking back over past elections, if the S&P has risen between early August and election day, the incumbent party has won 87% of the time. If it has declined over this period, the incumbent party has usually lost. In addition, so far this year the S&P 500 has risen nearly 40% since the beginning of April, with September being the only month to register a decline. Positive gains over the six months prior to an election have signalled victory for the incumbent 10 times out of the last 11 examples, with the only exception being the mid-term election in 2018. Could it be that despite the terrible economic ravages of the coronavirus pandemic, positive stock market sentiment could give Trump a second term?
Polls say ‘Biden’
Yet all the polling over the last few months has given Joe Biden a solid lead. What does this mean? It either suggests that investors are ignoring the polls, or that they are fairly relaxed about the prospect of a Biden presidency. Current analysis suggests the latter. The prevailing view is that while the Democrats will want to put up taxes, they will also be prepared to spend far more in fiscal stimulus than the Republicans, so boosting the stock market, if not the economy.
What’s not priced in
So, it looks as if investors aren’t really bothered about who wins the presidency. But one thing they don’t like to see is a ‘clean sweep’ where one party gets the presidency, along with majorities in both the Senate and House of Representatives. This creates too much opportunity for dramatic political change – something that really concerns investors. The preference is for a state of ‘gridlock’ which keeps Congress in check and maintains the status quo. As long as policymakers are restricted to playing at the margins, the feeling is that investors have little to worry about. A look at the US stock market suggests that investors are convinced that neither side will win all three.
Another major worry as far as markets are concerned is the danger of a delayed result. As noted earlier, investors hate uncertainty. If the result is too close to call on 4th November, then postal votes will play a major role in deciding the winner. Not only will this delay the announcement, it also guarantees a slew of legal challenges from both Republicans and Democrats. This brings back memories of the 2000 election when there were successive legal challenges to the Florida count meaning that it took several weeks to declare George W Bush the victor over Al Gore. Until recently this was a major worry for investors with many taking out options on the Volatility Index (VIX) to protect themselves for big market moves in November. But fears of a delayed result have also receded in recent weeks. No doubt as a result of the steady and significant poll lead that Biden has managed to maintain.
In summary, the polls point to a Biden victory, and current stock market behaviour suggests that investors are quite relaxed about this. But if we follow what stock markets have done before previous elections, then they suggest that Trump could emerge victorious. That would be a surprise. Other surprises would be a clean sweep by either Republicans or Democrats, giving one party the presidency together with majorities in both the Senate and the House. But perhaps the one thing that markets are now under-pricing, is the likelihood of no clear winner on 4th November. Finally, there’s one thing that is certain about this election: there’s never a dull moment.
Keep ahead with Smart News
You can follow everything that’s happening in the election by clicking on our Smart News widget. Here you can search for specific topics and read all the top news stories affecting financial markets. You’ll also see what the main influencers on financial social media are talking about and how they relate to the markets. Just click on the Smart News widget which you can find in the bottom right hand corner of our trading platform.