As the U.S. presidential election approaches, investors are preparing for the possibility of an unclear or contested outcome, which could disrupt this year’s impressive stock market rally.
With less than a month remaining until election day, current polls indicate a neck-and-neck race between Democratic candidate Kamala Harris and Republican Donald Trump. A recent Reuters/Ipsos poll shows Harris ahead by a narrow margin of 46% to 43%, reflecting an even tighter contest than previous weeks.
Given Trump’s ongoing attempts to challenge the results of the 2020 election, many investors are bracing for potential disputes should this election yield a close result. Furthermore, the congressional balance of power hangs in the balance, adding another layer of uncertainty with several races expected to be highly competitive.
“This is shaping up to be a very close election, and logically, the chance of some form of dispute arising is higher than average,” said Walter Todd, chief investment officer at Greenwood Capital. He warned that if election results remain inconclusive for more than a few days, it could lead to a sell-off in stocks.
“Uncertainty is the market’s enemy. A situation where we don’t know the identity of the president just days after the election would be unsettling for investors,” Todd added.
Despite the political uncertainty, the strong growth of the U.S. economy continues to fuel optimism in the stock market. The S&P 500 has surged by 21% this year, poised for a second consecutive year of double-digit returns.
However, the looming election remains on the minds of investors. The Cboe Volatility Index, which gauges demand for options that protect against stock price fluctuations over the next 30 days, has risen about six points from its September lows, currently standing at 20.9. This increase suggests a heightened expectation of market volatility, attributed in part to the upcoming election.
In options markets, there is a growing concern over “tail risk,” referring to a significant market downturn triggered by an unlikely yet impactful event. The Nations TailDex Index, which measures this risk, recently reached its highest level in a month.
Michael Purves, CEO of Tallbacken Capital Advisors, cautioned that investors might be overly focused on the immediate aftermath of the election. He pointed out that the true volatility could occur weeks later if the election result is perceived as illegitimate by a significant portion of the electorate. “The real risk lies in a litigated outcome that could lead to a market sell-off,” he stated.
Historically, challenged elections have had varying effects on the market. Following Trump’s attempt to overturn the 2020 results, U.S. stocks actually rallied in the days following the election, despite Biden not being officially recognized as the winner until days later.
Yet, investors this time may be more apprehensive, especially if either party initiates a challenge to a close result with the support of lawmakers and election officials in swing states.
Trump and his allies have signaled a willingness to contest a loss, citing unsubstantiated claims about widespread noncitizen voting, despite evidence showing such instances are exceedingly rare.
In the tumultuous election of 2000, the S&P 500 dropped 5% during the protracted uncertainty surrounding the Bush-Gore race, which lasted over a month due to a challenge based on disputed Florida results. The broader sentiment, affected by concerns about technology stocks and the economy, led to a total decline of 7.6% for that period.
Such instability could cloud the typically strong performance of stocks in election years. Historically, the S&P 500 has averaged a 3.3% gain in the final two months of presidential election years since 1952, with a rise occurring 78% of the time, according to Keith Lerner, co-chief investment officer at Truist Advisory Services.
Purves recommends that investors consider hedging against potential election-related volatility with put contracts, which increase in value when stocks decline.
Kurt Reiman, head of fixed income Americas and co-lead of the ElectionWatch at UBS Wealth Management, remains optimistic about the stock market but advises investors to explore safe havens like utility stocks and gold to protect their portfolios against the risk of a close or contested election outcome.
Stephanie Aliaga, global market strategist at JPMorgan Asset Management, noted that while a contested election may introduce volatility, such uncertainty is typically alleviated once results are finalized. “While elections create uncertainty, the resolution of election outcomes tends to clear that uncertainty, often resulting in a post-election rally,” she explained.
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