Markets Aren’t Great at Handling Contested Elections

(Bloomberg Opinion) -- It is increasingly likely that the outcome of the presidential election in November may take days, even weeks, to unravel. A recent model went so far as to predict a “Red Mirage” – the appearance of a Trump victory in the days before mail-in ballots tilted the election towards Biden.

This would be confusing and confounding in ordinary times. But such an outcome could lead to a prolonged, disruptive power struggle in this election given President Trump’s history of election fraud frauds — even when he won in 2016.

It goes without saying that this would be bad for democracy. But it might also spell trouble for something more prosaic: the stock market. There have only been two times in the past 150 years when the presidential election was not brought to a swift, unambiguous conclusion. The first happened in 1876, in the race between Democrat Samuel Tilden and Republican Rutherford B. Hayes.

The vote took place in early November, and while Tilden appeared to win, his lead consisted of a single electoral vote, with contested results in three states. The colossal mess that ensued wasn’t resolved until early March.

In the meantime, overall stock prices declined approximately 10%, according to data first compiled by the economist Alfred Cowles. But there’s little evidence to suggest this drop was tied to uncertainty over the election. While the New York Times noted in its coverage that “politicians, like stock gamblers, are divided into two classes – ‘bulls’ and ‘bears,’” the newspaper and virtually all others covering these events viewed politics and finance as effectively separate, and unlikely to influence one another.

Back then, presidents had far less influence over economic policy, so the stakes were simply lower for market watchers. Likewise, there was no round-the-clock, blow-by-blow coverage of Tilden versus Hayes. Traders didn’t have much information about the backroom machinations that eventually resolved the election, and they didn’t seem to pay it much attention.

The same, of course, cannot be said of the more recent contested election. In 2000, George W. Bush and Al Gore squared off. The morning after everyone voted, all eyes turned to Florida, where hanging chads left the outcome in doubt.

The market was not pleased. “Wall Street Wants a Winner,” declared the New York Times two days after the election. The NASDAQ took the deepest dive at first, plunging 5.4%. But other sectors endured far less dramatic declines, reflecting optimism that the whole business would be settled pretty quickly.

No such luck. Three days after the polls closed, Democratic candidate Al Gore gave a pugnacious interview, making it clear that he wasn’t going to throw in the towel without a fight. Share prices swooned, and a trader interviewed by the Wall Street Journal described the crux of the problem: “The market doesn’t like not knowing who the Leader of the Free World is going to be.”

The statement neatly captured how traders transform this abstraction we call the market into a sentient being that has, well, feelings. With all this talk of litigation, refusals to concede, and other electoral saber rattling, the market was starting to feel unwell. Indeed, by the end of November, the S&P 500 had plunged close to 10%; the NASDAQ had plummeted 19%.

But the ride was not a straight shot down. Instead, traders spent the last three weeks of November glued to their screens, watching every twist and turn of the recount. At one point, rumors circulated that Gore was going to throw in the towel; the markets quickly rallied. He emphatically dismissed them on television – and stocks dropped another 5%.

The entire period turned into an object lesson in risk and uncertainty as described by the economist Frank Knight in 1921. His key point can be boiled down to the contrast he drew between “measurable risk and unmeasurable uncertainty.” The first could be calculated and a wager made based on the odds; the second was a genuine shot in the dark.

The electoral uncertainty posed the latter problem. As Bush and Gore slugged it out over the course of November, traders quickly recognized that there was no real way to make a calculated bet on the outcome. Is it possible to count Supreme Court votes during an unprecedented crisis? What if an exhausted poll worker studying paper ballots miscounts the recount? The markets reacted predictably, if badly.

In fairness, some of the declines in the market reflected the fact that investors began spending more time and energy on corporate earnings and other conventional sources of data. But this scrutiny could also be interpreted as a shifting of anxiety about an uncertain election to the more familiar terrain of measurable risk.

When the Supreme Court issued its controversial decision in Bush v. Gore, the markets quickly rebounded. And not long afterward, they resumed a gradual decline, bottoming out a couple years later. But the downward drift was an understandable reaction to the growing tide of bad economic news that began accumulating in the new year. This was risk, not uncertainty.

The stakes are even higher in 2020. A sitting president with a penchant for divisive rhetoric, conspiracy theory and litigation. A challenger preparing for a protracted fight. A market that is rallying despite lockdowns and Covid-19, but capable of historic swings. A media environment driven by late-night presidential tweets and continuous coverage on cable news. It’s a recipe for maximal uncertainty, though investors can’t say they weren’t warned.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to Bloomberg Opinion.

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