Analysis-Risks from potentially contested US election appear on market radar by Reuters

By Lewis Krauskopf and Saqib Iqbal Ahmed

NEW YORK (Reuters) – A tight U.S. presidential race has some investors bracing for an unclear or contested election result that could dampen the stock market’s booming rally this year.

With less than a month to go before the election, polls and prediction markets show Democrat Kamala Harris and Republican Donald Trump in a virtual heat. Harris led Trump by a narrow 46 percent to 43 percent in a Reuters/Ipsos poll released Tuesday, a tighter race than the same poll showed a few weeks earlier.

Given Trump’s efforts to overturn his loss to President Joe Biden in 2020, investors expect any close result could be contested this year as well. The balance of power in Congress is also in play, with a series of potentially close contests that could add to the uncertainty.

“This is going to be a very close election. It goes without saying that the likelihood of some type of dispute occurring is higher than average,” said Walter Todd, chief investment officer at Greenwood Capital. He expects stocks to sell off if the outcome is in doubt for more than a few days.

“The markets don’t like uncertainty, and they certainly wouldn’t like the fact that we don’t know who the president of the United States is for a day or two after the election,” Todd said.

For now, political uncertainty doesn’t appear to be dampening enthusiasm for stocks, as strong U.S. economic growth has helped the power to new highs. The benchmark is up 21% so far this year and is on track for a second straight year of double-digit gains.

That doesn’t mean the election isn’t on investors’ radar. The Cboe Volatility Index, which measures demand for options for protection against stock market swings over a 30-day period, rose about 6 points from September lows and now stands at 20.9 – a level commonly associated with moderate to higher expectations for market turbulence. Part of the index’s rise is attributed to the looming election, investors say.

Options markets also reflect heightened concerns about tail risk — a shock to the market from an unlikely but high-impact event. The TailDex Nations Index, a measure of such risk, recently hit a one-month high.

Michael Purves, CEO of Tallbacken Capital Advisors, believes investors are too focused on the days before and immediately after the vote, when contested elections could affect markets in the weeks after November 5.

“It’s really not so much about the result as it is about the potential risk the next day that the election is not considered valid by a large part of the population,” he said. “To me, that’s a real risk … a litigated outcome where the stock market probably sells off.”

Recent precedents for contested elections are few.

Markets were largely unfazed by Trump’s attempt to overturn the results of the 2020 election. US stocks rose in the remaining trading days of the week after Election Day, even though Biden was not officially declared the winner until that weekend.

But investors may be less confident this time around, especially if a challenge to a close result by either party gains traction with fellow lawmakers and election officials in swing states.

For months, Trump and his allies have signaled they would contest a defeat, repeatedly saying they were concerned that large numbers of non-citizens would vote, though independent and state reviews show the practice is extremely rare.

Stocks took a nosedive in late 2000, when the race between George W. Bush and Al Gore was undecided for more than a month after a challenge by Gore’s campaign based on contested results in Florida, the clearest example of contested election in recent US history. .

From Election Day 2000 until Gore stepped down in mid-December, the S&P 500 fell 5%, when sentiment was also weighed down by unease about tech stocks and the broader economy. The index fell by 7.6% in the November/December period in 2000.

Such volatility could cloud the outlook for what tends to be a strong time for stocks in election years. The S&P 500 gained an average of 3.3 percent in the last two months of the 1952 presidential election, up 78 percent of the time, according to Keith Lerner, co-chief investment officer at Truist Advisory Services.

Purves, of Tallbacken Capital, advises investors to hedge potential election-related volatility with put contracts, which gain in value when stocks fall.

Kurt Reiman, head of Americas fixed income and co-leader of ElectionWatch at UBS Wealth Management, remains broadly bullish on stocks, but said investors should consider popular havens such as utility stocks and gold, to protect portfolios against a close or contested vote.

Stephanie Aliaga, global market strategist at JPMorgan Asset Management, said any volatility caused by the potentially contested election will likely be tempered once uncertainty subsides.

“Elections create uncertainty, but election results ultimately diminish and reduce that uncertainty,” she said. “At the end of the day, you end up with this almost post-election momentum or rally because the uncertainty is removed.”