Market Analysis

A tightly contested U.S. presidential election is prompting some investors to prepare for the possibility of an unclear or disputed outcome, which could disrupt this year’s robust stock market rally.

With less than a month to go before the election, recent polls and prediction markets show Democrat Kamala Harris and Republican Donald Trump in a near tie. A Reuters/Ipsos poll released on Tuesday indicates Harris leads Trump by a slim margin of 46% to 43%, reflecting a tighter race than in previous weeks.

Given Trump's attempts to overturn his 2020 loss to President Joe Biden, many investors anticipate that a close result could lead to disputes this year as well. The congressional balance of power is also at stake, with several potentially tight races adding to the uncertainty.

"This is going to be a very close election. It just stands to reason that the likelihood of some type of dispute occurring is higher than average," said Walter Todd, chief investment officer at Greenwood Capital. He predicts stocks may decline if the election result remains in limbo for more than a few days.

"Markets dislike uncertainty, and they certainly would not appreciate not knowing who the president of the United States is a day or two after the election,” Todd noted.

Currently, political uncertainty is not significantly dampening enthusiasm for stocks, as strong U.S. economic growth has driven the S&P 500 to new heights. The benchmark index is up 21% this year and is on track for a second consecutive year of double-digit gains.

Nevertheless, the election remains on investors' minds. The Cboe Volatility Index, which tracks options demand for protection against stock market fluctuations over the next 30 days, has increased by about 6 points from its September lows and now stands at 20.9—typically indicating moderate to high expectations for market volatility. Investors attribute some of this increase to the impending election.

Options markets also show heightened concerns about tail risk—market shocks caused by unlikely but impactful events. The Nations TailDex Index, which measures such risks, recently reached its highest level in a month.

Michael Purves, CEO of Tallbacken Capital Advisors, argues that investors are overly focused on the days immediately before and after the election, when a contested outcome could disrupt markets for weeks following November 5.

"It's not just about the outcome; it's also about the risk of the election being considered invalid by a significant portion of the population," he stated. "That, to me, poses a real risk… a litigated outcome could lead to a market sell-off."

There have been few recent examples of contested elections.

Markets remained largely unaffected by Trump’s attempts to overturn the results of the 2020 election. In fact, U.S. stocks rallied during the trading days following the election, even though Biden wasn't officially declared the winner until that weekend.

However, investors may be less optimistic this time around, particularly if either party's challenge to a close result gains traction among lawmakers and election officials in swing states.

Trump and his allies have been indicating for months that they would contest a defeat, repeatedly expressing concerns about noncitizen voting—despite independent and state reviews showing such occurrences are extremely rare.

A sharp decline in stocks occurred in late 2000 when the contest between George W. Bush and Al Gore remained undecided for over a month due to challenges from Gore’s campaign concerning disputed results in Florida, the most notable instance of a contested election in recent U.S. history.

From election day in 2000 until Gore conceded in mid-December, the S&P 500 fell by 5%, while concerns over technology stocks and the broader economy also weighed on market sentiment. Overall, the index declined 7.6% during the November/December period of 2000.

Such volatility could cloud the outlook for what is typically a strong period for equities in election years. Historically, the S&P 500 has averaged a gain of 3.3% in the last two months of presidential election years since 1952, rising 78% of the time, according to Keith Lerner, co-chief investment officer at Truist Advisory Services.

Purves from Tallbacken Capital suggests that investors hedge against potential election-related volatility using put contracts, which increase in value when stock prices drop.

Kurt Reiman, head of fixed income for the Americas and co-lead of the ElectionWatch at UBS Wealth Management, maintains a generally positive outlook on stocks, but advises considering safe-haven assets like utility stocks and gold to protect portfolios from a close or contested election.

Stephanie Aliaga, global market strategist at JPMorgan Asset Management, believes any volatility from a contested election would likely subside once uncertainty is resolved.

"Elections create uncertainty, but election results ultimately reduce that uncertainty,” she explained. “In the end, there tends to be a post-election boost or rally as the uncertainty clears."

Paraphrasing text from "Reuters" all rights reserved by the original author.