U.S. President Donald Trump speaks to reporters during a news conference in the Brady Press Briefing Room at the White House in Washington, September 18, 2020.
Kevin Lamarque | Reuters
The presidential election is the next known major event ahead of the Wall Street. Investment strategists are busy pushing out political playbooks, most of them starting with something like, “Clients continue to ask us about the implications of the election…” It’s the top-of-mind risk factor cited, a universal excuse for predicting autumnal volatility.
In other words, everyone is likely overplaying the election as a crucial or lasting driver of the market.
But isn’t this election a closely contested binary choice between too starkly different world views and economic philosophies, complicated by fears about election integrity and a delayed outcome.
Sure. But one reason to believe the election is overplayed as a decisive and exploitable market swing factor is that investors always overplay elections – and they rarely prove to be instrumental inflection points for economic or market cycles.
In order to treat an election as a specific catalyst for investment moves, one would have to handicap the result, anticipate the makeup of Congress, intuit the key policy priorities, evaluate the likelihood of them becoming law, estimate their economic impact and then determine how much of this decision tree has already been priced into financial markets. Sound doable?
From Reagan to Trump
What about Ronald Reagan ushering in the greatest modern bull market? Stocks were weak after the November 1980 election and were underwater until liftoff in October 1982 when a recession was ending and the Fed easier.
The Clinton ’90s nirvana for markets? The economy and stocks were already in recovery mode when he was elected in 1992 as the Fed kept rates low, and the big gains of the ’90s started after 1994 as policymaking became gridlocked.
Think the prospect of capital-gains tax rate hikes under a President Biden would kneecap stocks? Maybe there would be a flurry of front-loaded selling. But cap-gains tax increases in 1986 and 2013 did not derail strong bull markets.
And, famously, Wall Street wisdom had it wrong in 2016, when a Donald Trump win was viewed as dangerous for stocks. Aside from a fleeting 7% overnight S&P futures drop as returns came in, this was dead wrong, as an already nervous and guarded equity market quickly repriced for higher nominal growth, lower taxes and less fiscal restraint.
Yet even if an investor knew the result beforehand, the agreed-upon ways to play it were quite wrong. Energy and financial stocks were viewed as the best bets under a deregulatory Trump administration; they’ve been the worst sectors since 2016. After about a month’s rally in small-caps, oils and banks, the technology-led bull market resumed.
One of the more identifiable patterns in markets is not how they react to elections but how they behave leading up to them. Ned Davis Research notes that from Sept. 15 through Election Day in presidential vote years dating back to 1900, markets have done better ahead of incumbent-party wins than losses. And the lead-up is best for stocks ahead of Republican incumbent wins.
But the difference is between a median 3% gain and a 0.6% loss, hardly a vast performance gulf. And with only a few dozen presidential elections since modern markets existed, does the market experience under the various outcomes and party arrangements even offer a level of statistical significance that should dictate investment strategy?
Republican-incumbent losses are the worst for stocks ahead of an election, but guess what? That’s the very best of all the setups for market returns in the year after an election.
Market action in advance of this year’s election seems especially pronounced in a couple of areas. The price of protection against election-timed volatility in the market for VIX futures has been persistently high for months. In normal markets, the cost of VIX futures rises the further out in time the maturity sits. But the October and November VIX futures, the ones that would capture election-related market tumult, are above 30, and then prices decline for subsequent months.
Bond-market strategists also note a similar bulge in market-based volatility expectations around Nov. 3 in Treasury and corporate-bond instruments.
Which raises the question, if institutions are already well-hedged and clenched-up in anticipation of the vote this far ahead of time, will a result, any result, not trigger a tension release?
But what about an unresolved or disputed result? It would make sense for this to keep market anxiety elevated for a time. Goldman Sachs last week noted, “The markets’ expected one-day move on Nov. 4 [day after Election Day] has fallen from 3.2% in mid-August to 2.8% now, as investors assess the potential for it to take longer than usual to reach definitive election results.”
But even when the 2000 election was undecided for more than a month, the market unease around the election is not even viewed in retrospect as particular central to the market path – in that case an unfolding bear market that began eight months earlier and would not bottom until late 2002.
Jessica Rabe, co-founder of DataTrek Research, notes that the S&P 500 slipped 4.2% in the five weeks from Election Day 2000 until the Supreme Court ruled George W. Bush the winner. Yet it came shortly after an already pressured Nasdaq absorbed major earnings warnings from Microsoft and a raft of other tech firms.
As Rabe says, “Long-lasting and significant volatility usually stems from an economic shock as opposed to politically related issues.”
This isn’t to suggest the coming election can’t serve as a perfectly suitable excuse for further unsettled markets and rising investor risk aversion, now that the market leadership stocks have broken stride and the tape is in correction mode.
But of all the relevant factors – a resolutely supportive Federal Reserve, fitful economic recovery, strong housing demand, corporate profits rising from depressed levels, investors’ willingness to pay up for secular-growth stocks – it’s unlikely the election will be the thing to make or break this cycle.