Markets & Elections: What Really Drives Election Volatility?

Looking at market behavior around every U.S. presidential election since 1928, researchers discovered something surprising: the winner’s political party matters far less than electoral uncertainty. The closer the race, the stronger the market reaction.

The Uncertainty Factor

To identify truly close elections, researchers developed a metric based on state-by-state voting margins. If states won by less than 4% could have swung the Electoral College outcome, that election qualified as “close.”

Eight elections met this criteria, from Truman vs. Dewey in 1948 to Biden vs. Trump in 2020. The most dramatic? Bush v. Gore in 2000, decided by just 5 electoral votes with 116 electoral votes in contested states.

Compare this to Nixon’s 1972 landslide over McGovern by 503 electoral votes - the market’s reaction to each tells the real story.

Market Patterns That Matter

Close elections often lead to a more predictable market response.

Pre-Election:

• Markets consistently decline as uncertainty peaks

• Both Republican and Democratic investors reduce exposure

• Sharp rally typically emerges in the final week

• Pattern holds regardless of eventual winner

Post-Election:

• Averaged 2.5% gain in following 30 trading days

• Volatility spikes from 10% to 18% immediately after results

• Winners quickly return to market exposure

• Losers typically maintain defensive positions

The Investment Landscape

Different market segments show distinct patterns:

Small vs. Large Cap Performance:

• Small caps tend to under-perform before close elections

• After results, small caps tend to outperform by 2.5%

• This effect tends to be strongest in contentious races

Value vs. Growth Stiock Dynamics:

• Similar performance leading up to election

• Republican victory: Value stocks tend to gain 3%

• Democratic victory: Growth stocks tend to gain 2%

• Pattern holds across multiple election cycles

The Psych Behind the Moves

The research reveals a classic “risk-off, risk-on” pattern. When both sides view the opposing candidate as potentially disastrous, predictable market patterns emerge:

Before Election:

• Investors across political spectrum reduce exposure

• Both sides fear worst-case scenarios

• Defensive positioning creates downward pressure

• Cash levels rise as uncertainty peaks

After Results:

• Winning side’s fears dissolve

• Winners rapidly return to market

• Losing side already positioned defensively

• Net effect: Market typically rises

Global Confirmation

This isn’t just a U.S. phenomenon. Research across Australia, Canada, France, Germany, and the United Kingdom shows no statistical relationship between political parties and market performance. What matters is uncertainty, not politics.

Looking Ahead: 2024 - 2025 Implications

With another potentially close election approaching this week:

• Watch the “Magnificent Seven” tech stocks

• Democratic win historically favors growth stocks

• Republican win historically favors value stocks

• Pattern strength increases with election uncertainty

Markets don’t fear specific parties. They fear uncertainty.

- John

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Note: This newsletter is intended for informational purposes only.