Elections May Bring Market Growth ... or Gridlock

Stocks rose ahead of Tuesday’s U.S. elections, as investors appear to buy into elections-driven market volatility.

In an election cycle marked by division, violence and worries about the survival of democratic institutions, analysts see the buying trend continuing. Midterm elections typically boost market volatility, which drops after the election, according to a note from MSCI Research.

However, election results could skew how long volatility lasts. This year, voters will decide on 35 Senate and all 435 House seats, and the results will help decide whether President Biden is able to push through his Democratic agenda, or if a Republican majority brings legislating to a halt. 

Polls are currently showing Republicans will retake control of the House of Representatives, and the U.S. Senate, narrowly controlled by Democrats, is up for grabs. Changes boost uncertainty in markets, MSCI’S Abhishek Gupta and Roman Mendoza wrote in a note last week. 

“A flip in control has led to uncertainty around the ability of the president's party to pass bills and influence regulations,” which boosts volatility, they wrote. The opposite is true when control of the legislative houses don’t change: “The status quo generally translates into continued stability of the policy and economic roadmap with the reigning political party maintaining similar levels of control in terms of achieving its mandate.”

In turn, equity markets have performed higher in the months preceding an election, research shows, with returns on the S&P 500 soaring.

Source: Ameriprise  

Investors are already piling into the market, with the SPDR S&P 500 ETF Trust (SPY) rising nearly 1% Monday after ending last week down 3.5%. Meanwhile, the VIX volatility index has soared 47% this year.

For some analysts, including Morgan Stanley’s Chief Equity Strategist Mike Wilson, this means investors may want to bet on stocks in the weeks after the elections.

He added that polls pointing to Republicans taking control of at least one chamber of Congress might lead to lower bond yields and higher equity prices, which could keep the bear-market rally going. Analysts at JPMorgan echoed Wilson’s note, pointing to a bullish outlook on equities amid a potential peak in bond yields, “downbeat” investor sentiment and seasonal factors.

Treasury yields soared in the past week on the Federal Reserve’s announcement of a fourth consecutive 75 basis point rate hike, with the benchmark 10-year note reaching 4.21%, while the policy-sensitive two-year Treasury bill hit just over 4.72% by midday trading Monday.   

However, others have cautioned against betting on the election trend continuing this year, as decades-high inflation, roiling recession fears and dismal corporate earnings take their toll on markets.

“Post the 1950s elections, six and 12 months out, you generally see fairly decent and slightly above average returns on the S&P 500,” Rob Haworth, senior investment strategist at U.S. Bank, told ETF.com in an interview.

“The next one or two months, that's not necessarily quite as clear,” he said. “Our own current positioning is actually a little more on the defensive side.”

Contact Shubham Saharan at [email protected]