What to expect for the stock market after the election

What will the stock market do after the US election? With likely delays in finalizing the US election winner that could last weeks, what we can expect from the market:

• There will likely be a period of high volatility in which markets favor defensive stocks: Large Cap, Quality and Low Volatility companies
• Once the election results are known, Small Cap, Value and High Volatility stocks will outperform, regardless of which candidate wins
• The most important factor impacting the markets is not who wins but when.

Election Limbo

The 2020 US Election result limbo is here: there is no clear winner yet, with several potentially decisive battleground states still counting votes. Once the initial count is completed, we can expect the losing candidate to request a recount.

In some states it may be so close that a recount is automatically triggered by law. The electoral college doesn’t meet until early December and the new Congress doesn’t tally the final result until January 6, 2021. Depending how the losing candidate behaves, we could be in this ‘limbo’ state for up to two months. How will markets react?

We looked at what happened during the 2000 election delay (Bush vs Gore) to see what might happen this time. History says that until a winner is certified, defensive stocks such as Large Cap and Low Volatility will outperform. During this period of uncertainty, active managers are likely to move money into safe haven stocks with strong cash positions and profitability (Large Cap and High Quality).

Coupling US Election uncertainty with the rising number of COVID cases diminishes the prospects of a stimulus package until the election is resolved, or, in the case of a Biden win, possibly until his inauguration in late January. For that reason, markets are likely to follow the pattern established in March this year when they fell precipitously. Growth, Quality, Large Cap and Low Volatility stocks are likely to outperform in a falling market. We should also expect increased volatility in equity markets.

But, if the stock market shows stability or goes up during the uncertainty period, that suggests the market does not expect successful challenges to the preliminary election results.

What will happen with the stock market after the election winner is known?

Once we know who won the election, history clearly tells us that markets will rise regardless of which party takes the White House. Small Cap, Value and High Volatility stocks will outperform. Growth, Momentum, and Quality will underperform. These results hold regardless of which candidate wins (see Figures 1 and 2).

Our research shows that in the half-year period after seven of the past nine elections since 1984, three very specific investment strategies outperformed the rising markets: Small Cap, Value and High Volatility (see Figure 2).

Figure 2: Relative performance for each investment Style following each of the past nine elections. Republicans wins are in red and Democrat wins are in blue. The small (i) following the year indicates elections in which the incumbent won re-election. The returns in bold indicate the five years in which all three Styles outperformed their averages.

Why will stocks go up after the election?

This is because new Presidents (regardless of incumbency) tend to introduce stimulus packages which drive a recovery/growth economy. This encourages a risk-on investment approach, benefiting Small Cap and High Volatility stocks. These packages tend to be inflationary, which increases nearby cashflow and discounts long-term cash flow. In this environment, Value stocks tend to outperform Growth stocks. Small Cap and High Volatility also do well.

The difference in policy approach suggests that a Biden win would call for an accelerated stimulus package which could result in significant market performance starting as soon as his victory is recognized and extending through at least the first half of 2021. But the most important factor impacting the markets is not who wins but when. The markets want an accepted winner – the sooner the better.