Should investors be worried about a contested election?

There are countless studies, articles, and commentary suggesting that elections have little effect on long-term stock market returns. But a contested election — well, that’s a whole new ball game.

The concern, of course, is that a contested election could introduce an even greater level of uncertainty to investors and rattle the financial markets, but that concern may be overly pessimistic.

Here’s how Goldman Sachs economists put the issue in a recent report, in reference to trading levels of the S&P 500 Index of large U.S. companies:

“It seems fairly likely that there should be enough information on election night from states that will report results quickly for the market to be able to gauge the likely winner. In other words, the S&P can trade the likely outcome, even if the AP [Associated Press] does not call the race.” (Source: Bloomberg)

Stocks ended the third quarter of 2020 on a bit of a sour note. Since Sept. 2, the S&P 500 and NASDAQ Composite had fallen 6.1% and 7.4%, respectively, as of the end of the quarter.

The wall of worry is growing primarily because:

• Europe is seeing a resurgence of COVID cases, triggering more lockdowns;
• The 2020 election is likely to be contested and potentially undecided;
• Talk of a COVID-19 second wave beginning this winter;
• Hopes of a new stimulus package are fading; and
• China/U.S. geopolitical tensions (think TikTok).

All perfectly valid reasons to be concerned, and I’m actually a bit surprised that the recent selloff has not been steeper. But let’s not also forget that stocks were due to take a breather. From June 29 through Sept. 2, the NASDAQ had gained 22% while the S&P 500 had climbed over 17%. That’s an astonishing rate of return in just over two months. To see stocks give back some of those gains is not unreasonable, especially in the face of the growing number of concerns outlined above.

To see the entire picture, consider the third-quarter returns of the major market indices, which includes the recent declines:

Six months ago, I doubt there were many who would have predicted such an outcome. Still today, there are many who doubt the good times can continue, especially with the presidential election right around the corner.

Even if Goldman Sachs is correct, financial markets are unlikely to make any meaningful headway over the next several weeks.

Beyond that, however, there are some certainties which we believe should have a major influence on future market performance:

• The U.S. economy is expanding and recovering;
• Bond yields and expected returns offer an unattractive alternative to stocks;
• There is still $4.4 trillion of cash on the sidelines;
• Retail investors remain persistently bearish; and
• The Fed is dovish and supportive of asset prices (don’t fight the Fed!).

These factors are not typically associated with major market tops. Rather, they may be suggesting that stocks are in the early stages of a recovery.

However, the early stages of a recovery are typically when things are most uncertain and visibility about the future is poor. Fortunately, that visibility will become much clearer soon enough, as this election will be decided one way or another.

Until then, investors should remain patient, and remember that uncertainty and volatility are typically fueled by investor sentiment, which changes with the headlines of the day. But taking the long-term perspective, the fundamental reasons outlined above provide good reason to be optimistic about the future.

Brian Cayon is vice president – chief investment officer for Waukesha State Bank Wealth Management. He leads the investment services platform that includes directing investment and financial planning strategy and policies, asset allocation, and portfolio positioning.

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