How will the markets behave in the run up to the election? Some researchers see a positive trend in ... [+]
It is understandable that the 2020 U.S. election is being viewed as a period of elevated uncertainty by the financial markets. Indeed, 2020 has seen heightened economic uncertainty, regardless of political events. However, perhaps surprisingly, researchers have historically found positive trends in the markets in the few days right before election day.
Pre-Election Drift
Researchers at Quantpedia have found evidence of pre-election drift in the markets. This means that the market tends to trade up in the 5 days immediately prior to the election. The analysis is based on 35 U.S. elections from 1950 up to 2018, so it includes both Presidential elections and midterm elections. During this period, the market, in this case the S&P 500, has historically delivered an average return of approximately 2.5%. That may seem small, but if it holds, it is a relatively attractive return over 5 trading days. Interestingly, the run up seems to happen prior to the election. Immediately after the election, the markets tend to lack direction, historically speaking.
As with all quantitative research such as this, there are always open questions. Will this time be different? Perhaps, because there are now more quantitative researchers trying to trade these patterns. Also the pattern is not too distinct from the turn of the month effect, where the market tends to rise around the turn of the month. Therefore it is unclear if the driver really is the election or the more common turn of the month effect, whereby the first few trading days of the month have historically been good for stocks regardless of electoral activity. Finally, of course, 2020 is in many ways a unique election and perhaps history will not serve as a useful guide.
An International Perspective
When observing trends such as this in U.S. markets it can be helpful to validate internationally. Angela Opare has conducted similar research across multiple European stock markets and found broadly similar trends. She examined 13 European countries holding elections between 1990 and 2012. Once again, the markets tend to, on average, rise in the lead up to an election, only to decline after the election occurs. Specially she identifies positive returns in the 15 days before an election and negative returns in the 15 days following the election result. The study also, perhaps unsurprisingly, does show heightened market volatility around elections. This is a slightly different framing to the findings of the Quantpedia research above, but the findings are broadly consistent.
What Will The 2020 Election Hold?
If history is any guide the markets may enter a period of heightened volatility as the election approaches. Though, 2020 is somewhat unique as economic risks are already elevated due to the pandemic.
The historic picture of the markets rallying in the final few days ahead of an election appears robust, on average. And indeed, the markets may have a directionless or negative period once the result is known. As quantitative data goes, this trend appears relatively well supported, holding up over different time periods and in the U.S. as well as Europe.
That said, as with most quantitative trends you cannot bank on them every year. In the worst case the markets have fallen 10% in the days before an election, so bad outcomes can happen. Though an average 2% plus return over just a few days before an election is a relatively strong result, it may also be considered a payoff to investors for the heightened volatility that electoral uncertainty can cause.
