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Analytics, 06 November 2020

US elections: how the stock market reacts?

The stock market certainly loves uncertainty. Even as investors anxiously wait for results from key states that will prove decisive in the US presidential election, as early as last week markets were already anticipating a Biden victory. Markets are known to react to news and any news related to elections will continue to drive the market in the coming days. The news we’ve been seeing so far is the likelihood of a Biden Presidency, lawsuits and attempts at lawsuits to contest the results.

Will markets react positively if Trump is reelected? After all, he stands for deregulation and tax cuts.

Or will a Biden win move the needle in the right direction, in the hope that he brings stability to the White House?

The election and the results

Until recently, the negotiations around a possible second round of stimulus appeared to be what has been driving up stocks. Indeed, many were saying the reason the stock market was rising in the fall along with Joe Biden’s poll numbers was that they expected a win for the former vice president would raise the odds of more stimulus spending.

The US presidential election week started with the stock market predicting Joe Biden’s victory, as per the reading on the market’s presidential predictor, which has been successful 88% of the time since 1944. Even as millions of votes were still being counted Wednesday, the Dow Jones industrial average rose nearly 370 points or 1.3%, the S&P 500-stock index added 2.2%, and the technology-heavy Nasdaq rose roughly 4%.

The stock rise following the election indicates that Wall Street thinks more stimulus is still coming. That could be because investors believe Biden will likely emerge as the next president. But it could also mean that a narrow win for Mr. Trump could signal voter dissatisfaction and cause the president to reconsider the need for a stimulus.

US stock predictions and their outcome

According to the stock markets “presidential predictor”, since World War II, when the S&P 500 has shown negative performance in the three months before the presidential elections in November, the outgoing president, and the incumbent party has lost the race for presidency 88% of the time.

Accordingly, when the S&P moved positively during the same 3-month period before the elections, the outgoing president and his incumbent party kept the office 82% of the time.

This was observed again in 2016. Even when the polls were wrong, predicting the victory of Clinton over Trump, the stock market’s “predictor” was right. The S&P 500 fell by 2.2% during the three months leading up to the election day in November 2016, and signified that the Democrats would be defeated, meaning that Donald Trump would get more votes than Hillary Clinton despite the poll results.

Before election day, Wall Street’s forecasts matched the “presidential predictor”, expecting a “blue wave” with the Democrats winning the White House. Goldman Sachs believes it could be good for markets, sharply raising the probability of a stimulus package of $2 trillion after the January 20 presidential inauguration.

According to Moody’s Analytics, if introduced, Biden’s economic proposals would create 7.4 million more jobs than Trump’s, turning the economy back to full employment by the second half of 2022.

Outlook: how presidential elections affect stock markets?

Analyzing how presidential elections affect the stock market, US Bank reviewed the S&P 500 market data going back to the 1930s. They managed to define certain patterns that emerged over those 90 years. They revealed several variables that affect stock market performance. It does not make much difference which party takes the office, but it does matter if control changes.

When a new party comes to power, the stock market increases by 5% on average. When the same president wins the election, or one party keeps control over the White House, the markets show slightly higher results of a 6.5% gain. However, although the election brings volatility to the markets, which can be frustrating, it also creates great opportunities to invest in equities, or at least to trade stock market indices like the S&P 500.

How will markets react to the outcome?

Will markets react positively if Trump is reelected? After all, he stands for deregulation and tax cuts. Or will a Biden win move the needle in the right direction, in the hope that he brings stability to the White House?

Either way, the election outcome will define the next four years and it’ll be interesting to observe the market’s initial reaction to the result. The past five presidential elections didn’t evoke extreme market reactions, with Barack Obama’s first triumph in 2008 a notable exception. Back then, the S&P 500 dropped 10% the first two days after the election, although it needs to be noted that that election took place in the middle of the financial crisis, which left markets particularly volatile.

Trump’s victory four years ago didn’t prompt an extreme market reaction, despite the surprising nature of his win over Hillary Clinton. Back then, the S&P 500 climbed 1.1% on the post-election day and continued its generally upward trend the days that followed.

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