Monday, September 28, 2020

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A contested election may already be priced into the market

The idea of a contested U.S. presidential election is certainly cause for concern. For investors, elevated uncertainty is associated with lower stock prices.

But don’t forget: Stocks move based on expectations for the future. Which leaves us asking: What are markets expecting?

“A contested election has become the baseline,” JPMorgan strategist John Normand wrote in a note to clients last week.

That’s one strategist’s expectation. But with all the bluster around the idea of a contested election, which includes President Trump suggesting he may not honor the results, we have to consider the possibility that much of this is priced into the stock market (^GSPC), which is down about 8% from its early September high.

In fact, the analysts at Goldman Sachs believe the markets could be overpricing this outcome.

“On timing, we think the market appears to be pricing too high of a probability that it will take a long time to sort out the winner,” Goldman Sachs’ Michael Cahill and Alec Phillips said on Thursday.

“We agree this is certainly a tail risk, but a number of states—including some key Battlegrounds—allow votes to be processed and counted well before Election Day,” they added. “Taken together with cross-state correlation on many sources of polling errors, it seems likely that markets will have enough information on Election Night or soon thereafter to gauge the likely winner, even if the race takes longer to be officially called.”

And so if it is the case that the market has priced in the expectation for a contested election, then an actual contested election — all things being equal — would be unlikely to trigger more volatility (assuming it gets sorted out in a reasonable amount of time). Furthermore, if the results of election night are accepted right away, then maybe prices actually go up.

(At this point, the question reverts to who you think will win and what the make up of Congress will look like. While the impacts on specific sectors will vary depending on the outcome, analysts generally agree that neither candidate would be negative for the markets overall. For more, read here and here.)

The idea that the stock market at any given time is reflecting some expected future outcome has been on display for much of the year. Back in late March and early April, we wrote about how the market may have already priced in much of the economic pain that was to come. If that were true, then the market would likely rise based on consensus expectations for an economic snapback, which eventually came.