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By Swissquote Analysts
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How could the upcoming US election affect the stock markets?

By Ipek Ozkardeskaya
Published on

The Covid pandemic didn’t leave much space for other talking points in the markets this year. But the US election is roughly three months away and the investor attention will somewhat shift towards what’s happening on the US political front in the lead up to the November election and how different election outcomes could impact the performance of the US stock markets.

Historical data shows that the stock market volatility tends to increase in the months leading up to an election. This is due to the political uncertainties and the continuous assessment of pole results and market expectations.

As a rule of thumb, a Republican lead is supportive of stock prices as Republicans focus on enhancing company earnings and shareholder profits, while a Democrat lead would have the opposite impact on equity prices as Democrats would concentrate on redistribution of wealth, and social rights and benefits.

Also, markets tend to perform better when the ruling president stays in office. It is, again, a matter of more certainty, and a switch from Republican to Democrat government could have a negative impact on stock prices as investors factor in business-unfriendly changes such as stricter rules, higher corporate taxes and so.

But this time, it is different. The US economy has been struggling with an unprecedented recession due to a global pandemic that has ravaged all layers of businesses across the country. Donald Trump is highly criticized for his poor management of the public health crisis that resulted in the US being the worst-hit country by the pandemic worldwide.

With roughly 15 million unemployed and a skyrocketing government debt, the US economy is not out of the woods just yet, even though the V-shape correction in the US stock markets distort the perception of the underlying fundamentals and paint a drastically different picture compared to what’s really happening on the field.

Forbes magazine writes that the stock market and the economy are key indicators of who wins a presidential election, highlighting that avoiding a recession in the two years leading up to an election is a key indicator of reelection. In the past century, presidents who averted recession during this two-year period have been reelected.

Likewise, a positive performance in the S&P500 during the three months leading up to an election has been a major sign that the ruling president would be reelected and a negative performance in the S&P500 would hint at a new government taking over. According to Forbes, the S&P500’s three-month performance has predicted up to 87% of the election outcome since 1928, and 100% since 1984.
But in the past, the stock market performance has been at least a little bit in line with the underlying economic fundamentals. This is clearly not the case this year. In fact, the massive monetary and fiscal stimulus pumped a gigantic amount of liquidity into the financial markets, triggering the fastest rebound in equity prices following a bear market. Meanwhile, the real economy has been left behind the market euphoria and saw a moderate recovery only.

So if we look at the actual state of the economy, Donald Trump is in a difficult position as he has been the victim of the worst economic recession of our lifetime, and the situation will unlikely get significantly better by the time voters go to the ballots. But if we look from a stock market perspective, he is not doing too bad.

The 2020 will show what matters the most to voters: the stock market performance, or the real economy.

The election polls showed up to a two-digit advance for Joe Biden over Donald Trump, even though the latest polls hint that Biden’s lead significantly narrowed since June. But there is no sign of stress regarding the Biden-lead across the US equities. Provided the cataclysmic economic conditions, Democrats can’t do much harm to the financial markets, fearing that any weakness across equities would have broader implications for the economy. So, investors are convinced that the pandemic would somehow protect their capital gains even under a Democratic government.

On the other hand, even though a handover to a Democratic government might have an early negative reaction of some 2-3% drop in major US indices, the historical data reassures that the kneejerk sell-offs have been short-lived and the stock prices recovered the year following an election, regardless of who got elected.

Nevertheless, this time around, the US election is not necessarily about who will win the race. A Democrat win is not the major risk to the US stock prices.

The leading risk to the 2020 US election, and the equity markets, is a possible delay.

If the pandemic prevents the US voters from heading to the polls on November 3rd, voting by mail seems to be a safe option.
Yet, to win some time, Donald Trump is willing to postpone the November 3 election. In a recent tweet, the president warned ‘with the Universal Mail-In voting, 2020 will be the most inaccurate & fraudulent election in history’. But Trump doesn’t have the power to postpone the election himself, the decision should be approved by the Senate.

For now, any delay is highly unlikely, but if it happened, it could cause strong headwinds across the financial markets, as investors don’t like political disruptions, and even less uncertainties.