The Ivory Hill RiskSIGNAL™ has remained green since December 5, 2023, and the long-term trend is still strong. Our short signal is green, while our mid-term volatility signal is red but fading towards green.
Today’s presidential election could take several days before an official winner is announced, which would lead to significant volatility in both the stock and bond markets. There’s a sense that investors are pricing in a Trump victory, which might be influencing current bond market behavior. Given how close the race is, it seems unlikely that either outcome would catch the markets off guard. Ultimately, the markets might opt to “sell the news” as a way of responding to the resolution of some uncertainty.
There is little uncertainty around the Fed’s expected quarter-point rate cut this week. For months, I have been saying that inflation would accelerate in Q4, and that is exactly what happened. Inflation has indeed started to climb, and after this cut, all attention will inevitably shift back to the Fed (insert eye roll here). If inflation continues to accelerate, the Federal Reserve may need to reconsider its current monetary policy stance. This could involve maintaining interest rates at their current levels for a longer period than the market anticipates or potentially implementing rate hikes to curb rising inflation. (It wouldn’t be the first time the Fed made a policy mistake.) Such actions would aim to prevent the economy from overheating and to keep inflation within the Fed's target range. However, these measures could also impact economic growth and employment, making the Fed's decision-making process particularly challenging as it balances these economic objectives.
Cash on the sidelines
We have seen money market fund inflows increase by over 402 billion. There is a massive amount of cash on the sidelines that, if, and I say if, rates start to drop, should find its way back into the equities market.
Interest rates have been steadily climbing since the Fed cut rates, as investors are increasingly aware of the nation’s escalating debt and its rapid growth. Rates now seem overextended, indicating a potential reversal that could drive bond prices upward.
I've structured this report into two distinct sections. The first, What to Watch For, outlines the current state of the election and provides a guide on what to watch for on election night to determine the likely winner. The second section takes a market-focused approach, examining how various political outcomes could impact market behavior and investor sentiment. On a personal note, I’ve been aiming to release this report over the past few days, but the rapidly shifting data landscape has made it challenging. I hope you find it valuable, and I would greatly appreciate any feedback you have.
What to Watch For
This election could be the closest election since the George W. Bush vs. Al Gore race in 2000.
If you don’t remember, that was one of the most contentious elections in American history. Initially, the race was too close to call on election night, and the outcome hinged on Florida's 25 electoral votes. Various news networks called the state for both candidates throughout the evening, leading to widespread confusion. The election's final result remained unresolved due to recounts and legal challenges.
The controversy centered on Florida's razor-thin margin of victory and issues with the voting process, including "hanging chads" on punch-card ballots and the interpretation of voter intent. The Florida Supreme Court ordered a manual recount of votes in several counties, but the U.S. Supreme Court intervened. On December 12, 2000, in the landmark case Bush v. Gore, the Supreme Court effectively ended the recounts, declaring that no constitutional method for conducting a recount could be established within the required time frame. As a result, the state-certified count was allowed to stand, and George W. Bush was declared the winner in Florida, securing the presidency with 271 electoral votes to Al Gore's 266.
Given that the court cases have already started, I feel like I am not going out on a limb by saying this election could very well take several weeks to get ironed out in the courts.
What does this mean for markets? It means we should expect short-term volatility and this will bring us some good buying opportunities.
If you look at the betting markets and polls, they are still showing a pretty tight race.
As it stands, the betting markets are favoring Trump, while the polls remain a virtual toss-up. Neither the polls nor the betting markets are providing us with clear insights, given the unique dynamics of this election.
The data indicates an exceptionally close race. Even here in Minnesota—a state that hasn't supported a Republican presidential candidate since the Nixon era 52 years ago—appears to be up for grabs.
Here’s what to look for instead of watching the polls.
Introduction
As we approach the presidential election, it is crucial to understand that either candidate has a viable path to victory. Despite markets having partially priced in a Trump win and potential Republican sweep, the race remains highly competitive, and Harris still has a significant chance of success.
Market Sentiment and Expectations
Recent market movements, including the rally in equities and the rise in Treasury yields, reflect the market’s anticipation of a Trump victory. The rationale behind these moves is the perception that Republicans are pro-growth, while their economic policies, particularly those surrounding government spending, are viewed as more deficit-expanding compared to Democratic proposals. However, despite this pricing, polling data paints a picture of a closely contested election.
According to the Real Clear Politics (RCP) national polling average, Trump leads Harris by a narrow 0-point margin (48.5% to 48.5%). This indicates a highly competitive race. Further analysis reveals that three of the seven key swing states have margins of less than 1%, while the remaining four show margins under 3%, emphasizing the tightness of the contest. Thus, as we head into election night, it is essential to recognize that either candidate could emerge victorious.
The Montana Senate race is the most critical election today.
One of the most significant factors for the markets beyond the presidency is the Montana Senate race. The broader composition of the government hinges on three possible outcomes: a split government, a Democratic sweep, or a Republican sweep. However, due to the current Senate re-election map, it appears highly likely that Republicans will maintain a 51-49 seat majority, effectively eliminating the possibility of a Democratic sweep.
Two critical races further illustrate this.
In West Virginia, Republican Jim Justice holds a substantial lead over Democrat Glenn Elliott, making it highly likely that the seat will flip to Republican. In Montana, Republican Tim Sheehy leads incumbent Jon Tester by approximately seven points, and if this lead holds, the seat will also likely flip to the Republicans. If there are no major Senate upsets, the only viable outcomes will be a Republican sweep or a split government. Consequently, investors do not need to factor in the implications of a Democratic sweep.
Focus on Swing States
For the presidential race, national polls are less relevant than the outcomes in seven key swing states: Georgia, North Carolina, Pennsylvania, Wisconsin, Michigan, Arizona, and Nevada. As it stands, Trump holds a narrow lead in five of the seven states according to the RCP polling average, but the margins are slim.
The outcomes in North Carolina and Georgia, whose polls close relatively early, will serve as critical indicators of the election night dynamics. Trump currently leads in Georgia by 1.7 points and in North Carolina by 1.3 points. A strong performance by Trump, with early calls in these states, would suggest he is outperforming polling expectations elsewhere. On the other hand, if these states are too close to call or if Harris wins one of them, it would signal a favorable trend for Harris and indicate potential polling inaccuracies would not be surprising either. This is really a toss-up until the results are in.
Path to Victory and Critical Electoral Votes
Winning the presidency requires securing both Sun Belt and Rust Belt states. Trump has an advantage in three of the Sun Belt states: Georgia, Arizona, and North Carolina. However, simply winning these states isn’t sufficient. If Harris were to win all three Rust Belt states (Pennsylvania, Wisconsin, and Michigan), she would secure the presidency with 272 electoral votes to Trump's 268, even if he won the Sun Belt states. This means that Trump must capture at least one Rust Belt state in addition to sweeping the Sun Belt to secure victory.
Election Night Uncertainty and Market Implications
Given the tight race, there is a realistic possibility that no clear winner will be declared by Wednesday morning. Challenges, recounts, and litigation could delay the final outcome. Despite this, markets are expected to react to preliminary results and projected outcomes. As the results unfold, I will continue to interpret and communicate the implications for the markets, ensuring that you are well-informed of the evolving situation.
Good/Bad/Ugly Election Scenario Analysis
Introduction
This is part two of our “election coverage,” where we dive into a Good/Bad/Ugly election scenario analysis. The analysis here is solely market-oriented, centered on how different political outcomes might influence market behavior and investor sentiment. Importantly, this assessment does not express a political opinion or endorse any party. It is a strategic evaluation of potential market reactions to various election results based on the information that I have today. As always, it is essential for individuals to vote based on their values, respecting differing perspectives and choices.
Good Outcome for Markets: A Republican Sweep
Scenario Description: A Republican sweep entails winning the presidency along with control of both chambers of Congress.
Likely Market Reaction: A Republican sweep is expected to accelerate the rally heading into year-end. Historically, markets perceive Republican policies as pro-economic growth, with a focus on deregulation and tax cuts. These measures are anticipated to enhance corporate profitability and boost consumer spending, thereby energizing the market.
Impact Analysis:
S&P 500 Projections: The index could surge above our new measured move target of 5,907, making new ATHs at 6,000, which is very possible by year-end, reminiscent of the market surge observed after the Republican victory in 2016.
Sector and Factor Performance:
Leaders: Small caps, mid-caps, value-oriented, and cyclical sectors are likely to outperform. Beneficiaries include industrials, banks, energy, materials, transports, and small-cap stocks due to pro-growth and deregulation policies.
Laggers: Mega-cap tech and sectors reliant on growth themes (e.g., consumer discretionary and communications) may underperform.
Broad Market Trends: All 11 S&P sectors are projected to experience gains, though cyclical and domestically focused sectors should lead.
Key ETFs and Indices: The equal-weighted S&P 500 index (RSP) should outperform the traditional market-cap-weighted S&P 500 (SPY), and value (VTV) investing is expected to eclipse growth (VUG).
Considerations: While the rally is anticipated to broaden, all sectors could benefit to some degree, even though small caps and value are expected to outperform.
Bad Outcome for Markets: A Split Government
Scenario Description: A divided government scenario, where one party controls at least one of the presidency, Senate, or House, would yield mixed outcomes for markets.
Likely Market Reaction: The rally could continue but at a more measured pace. A split government often removes the possibility of major disruptive policy changes, giving investors room to concentrate on existing macroeconomic strengths, including solid economic growth, Federal Reserve rate cuts, and declining inflation.
Impact Analysis:
Growth and Fed Policy: Assuming no significant shocks to economic growth or unexpected changes in Fed rate policies, the market could maintain gains and possibly achieve modest growth into the year-end.
Sector and Factor Performance: Stability is likely, with no single sector significantly outperforming others. Gains would be more evenly distributed across the market.
Seasonal Trends: The traditional "Santa Claus rally" could support a gradual upward trend in the market.
Valuation Constraints: The S&P 500’s high valuation, at 22 times earnings, would remain a limiting factor, as there would be no fresh pro-growth legislative policies. Thus, while economic conditions would prevent losses, significant upward movement would also be constrained.
Ugly Outcome for Markets: A Democratic Sweep
Scenario Description: This outcome entails Vice President Harris winning the presidency and Democrats securing control of both the Senate and the House.
Likely Market Reaction: A Democratic sweep would likely cause a market pullback. The market's apprehension stems from expectations of increased regulation and potential tax hikes, which could negatively impact corporate profits and broader economic growth.
Impact Analysis:
Market Reaction: A decline of more than 1% in the near term would not be surprising, and a 5%–10% pullback could be expected in the subsequent weeks as investors adjust to a more business-regulatory environment.
Sector and Factor Performance:
Laggers: Cyclical sectors and economically sensitive stocks may face pressure.
Leaders: Mega-cap tech, healthcare, utilities, staples, and foreign markets could experience relative outperformance due to a shift toward defensive positioning.
Expectations: The market would be pricing in a less business-friendly administration, and short-term volatility should be anticipated. However, the likelihood of this scenario remains low based on current political forecasts.
Political Significance: The Montana Senate race, among others, will be crucial, and its outcome could swing the balance of power, making it a focal point of market speculation.
Key Wildcard: The 10-Year Treasury Yield
The 10-year Treasury yield is a crucial wildcard, shaping market sentiment and impacting asset prices based on election outcomes.
Republican Sweep Impact: Markets expect pro-growth but deficit-expanding policies under a Republican sweep, leading to higher yields. Despite this, an accelerated market rally into year-end could still occur, driven by optimism around economic expansion. However, rising yields could become problematic in 2025 as deficit concerns take center stage.
Democratic Sweep Impact: A Democratic sweep might drive yields lower, with markets anticipating slower growth and more deficit-friendly policies. This decline could provide some relief for rate-sensitive sectors, but concerns over increased regulation and taxes would likely weigh on overall market sentiment.
Looking Ahead
The 10-year yield's trajectory will play a pivotal role beyond the immediate election impact, especially as fiscal issues come to the forefront in 2025. Higher yields could slow market momentum, while lower yields may not fully offset economic concerns, making ongoing fiscal policies a key source of future market volatility.
Conclusion
The most favorable market scenario appears to be a Republican sweep, likely driving a strong rally into year-end. However, this outcome could lead to heightened volatility in 2025 as fiscal challenges, such as deficits and rising debt, become more prominent. Conversely, a split government may provide market stability but limit growth potential due to valuation constraints. A Democratic sweep, though less probable, could result in immediate market setbacks due to regulatory and tax concerns.
The upcoming election has the potential to either amplify or moderate the current market rally or reverse gains significantly. Ultimately, the market's movements will hinge on anticipated policies and fiscal expectations, with the reality of Washington's governance coming into focus in 2025. Prepare for a more volatile fiscal landscape ahead.
How Has the Presidential Election Impacted the Market?
Since 1952, in 9 out of 18 presidential election years, the market posted gains on the first trading day after Election Day. However, the average return of -0.23% was significantly impacted by sharp declines in 2008 and 2012, when the S&P 500 dropped by -5.27% and -2.37%, respectively. In the last two elections, the market responded more positively, showing greater optimism about a Biden presidency in 2020 compared to Trump's win in 2016. Overall, the S&P 500 tended to perform well in the post-election period, with gains recorded in the two months leading up to inauguration day for 11 of the past 18 elections.
How does the market react when an incumbent president is re-elected? What about when the challenger wins?
Historically, the S&P 500 has often posted positive returns between Election Day and Inauguration Day, regardless of the election outcome. Since 1952, the most substantial gains in this period have typically occurred when a Democratic incumbent was reelected. Conversely, when the election involves neither an incumbent nor a direct challenger—such as when a sitting president is termed out—the market has tended to yield lower returns during the same timeframe. As of July 21, 2024, the upcoming election falls into this "neither" category, which historically has been associated with more modest pre-inauguration market performance, particularly if a Democratic candidate is elected.
How does one-party control or a divided Congress impact market returns?
Historically, the stock market has seen higher average annualized returns when Congress is divided, with one party controlling either the House or the Senate while the other party holds a majority in the other chamber. In contrast, returns have generally been lower when Democrats have held majorities in both chambers, while higher returns have often been observed under full Republican control of Congress. Nevertheless, the market has tended to show positive performance across all six possible government arrangements. Since the current Congress was sworn in on January 3, 2023, with a Democratic president and a divided legislative branch, the S&P 500 has risen by 50.08% (equivalent to 26.06% annualized) as of September 30, 2024. This significantly exceeds the historical average annualized return of 15.72% for this type of government setup.
How did asset classes perform under the last two presidents?
Stocks generally showed strong performance under both administrations, except for Emerging Markets (EM). While EM gained 72.1% during Trump’s term, it has declined by 6.5% as of the third quarter of 2024 in Biden’s presidency. Bond indices also saw gains under Trump but have shown weaker performance under Biden so far.
On the other hand, commodities, which were the poorest-performing and the only asset class in negative territory during Trump’s time in office, have become the top-performing asset class under Biden.
Regardless of who is elected, I believe the stock market will end the year higher than it is today. Any correction is likely to be capped at around 7-8% at worst for the major indexes, and that would be a buying opportunity. On the upside, if clarity emerges, we could witness a powerful rally, regardless of the election outcome. In that case, increasing exposure to the key sector styles I've highlighted will be essential.
And remember - The one fact pertaining to all conditions is that they will change.
Feel free to use me as a sounding board.
Best regards,
-Kurt
Schedule a call with me by clicking HERE
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Email: kurt@ivoryhill.com | ivoryhill.com
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