Analysis-Risks from potentially contested US election appear on market's radar

By Lewis Krauskopf and Saqib Iqbal Ahmed

NEW YORK (Reuters) - A tight U.S. presidential race is leading some investors to brace for an unclear or contested election result that could trip up this year’s booming stock market rally.

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

Given Trump's efforts to overturn his loss to President Joe Biden in 2020, investors expect any close outcome might also be contested this year. The balance of power in Congress is also at stake, with a number of potentially close contests that could ratchet up 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 it is on average," said Walter Todd, chief investment officer at Greenwood Capital. He expects stocks to sell off if the result is in doubt for more than a few days.

"Markets do not like uncertainty, and they certainly would not like the fact that we don't know who the president of the United States is a day or two after the election,” Todd said.

For now, political uncertainty appears to be doing little to dampen enthusiasm for stocks, as strong U.S. economic growth has helped the S&P 500 power to fresh highs. The benchmark index is up 21% so far this year and on track for a second straight year of double-digit gains.

That’s not to say the election isn’t on investors' radar. The Cboe Volatility Index, which measures options demand for protection against stock swings within a 30-day period, has risen about 6 points from its September lows and now stands at 20.9 - a level typically associated with moderate to higher expectation for market turbulence. Some of the index's rise is attributable to the looming election, investors say.

Options markets also reflect increased concerns about tail risk - a market shock due to an unlikely but highly impactful event. The Nations TailDex Index, a measure of such risk, recently hit its highest level in a month.

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

"It's really not so much about the outcome as it is about the potential risk of the morning after, of the election not being considered valid by a large part of the population," he said. "That to me is a real risk ... a litigated outcome, where the stock market probably sells off."

Recent precedents for challenged elections are few.

Markets were largely unperturbed by Trump’s attempt to overturn the results of the 2020 election. U.S. stocks rallied in the week's remaining trading days after election day, even though Biden wasn't officially declared the winner until that weekend.

But investors might be less sanguine 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.

Trump and his allies for months have been signaling that they would challenge a defeat, claiming repeatedly that they are worried that large numbers of noncitizens will vote, though independent and state reviews show this practice is vanishingly rare.

Stocks notched sharp declines in late 2000, when the race between George W. Bush and Al Gore was undecided for more than a month after a challenge from Gore’s campaign based on disputed results in Florida, the clearest example of a contested election in recent U.S. history.

From election day of 2000 until Gore conceded in mid-December, the S&P 500 slumped 5%, when sentiment was also weighed down by unease about technology shares and the broader economy. The index slid 7.6% for the November/December period overall in 2000.

Such volatility could cloud the outlook for what has tended to be a strong time for equities in election years. The S&P 500 has gained an average 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, of Tallbacken Capital, advises investors to hedge potential election-related volatility through puts contracts, which gain in value when stocks fall.

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



Stephanie Aliaga, global market strategist at JPMorgan Asset Management, said whatever volatility a potentially contested election causes would likely be mitigated once the uncertainty subsides.

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

Source: Investing.com