Elections can significantly impact the financial market due to the uncertainty it brings from each candidate's views on specific policy issues, which can cause the market to become volatile.
The results of an election, combined with the winners' policy changes in various sectors such as healthcare, trade, taxation, and economy, can cause market participants to adjust their portfolios so that they don’t get caught off-guard once these changes occur.
Traders can monitor market sentiment during times of volatility with the help of tools like the VIX (volatility index), which indicates market uncertainty and fear. This is also why the VIX is known as the “fear index.”
The VIX is inversely related to the S&P 500 because this index represents about 80% of the total value of US stocks. That said, traders and investors can still use the VIX to get a broader overview of the entire US stock market.
It’s critical for traders and investors to understand these dynamics, specifically during election seasons. We’ve created this article to take you through all the essential aspects you might need to know.
Key Takeaways
- Elections can bring a certain degree of uncertainty to the financial markets that can lead to increased volatility when market sentiment shifts.
- Changes in presidential administrations can result in adjustments to monetary and fiscal policies, which can have a diverse effect on different market sectors.
- The VIX is used to gauge market sentiment.
- The VIX is inversely related to the S&P 500, which means when the S&P 500 increases, the VIX decreases and vice versa if the S&P 500 decreases.
- The VIX generally tends to rise during election seasons due to the degree of uncertainty that comes along with it.
How Market Volatility Is Affected by Political Uncertainty
Elections, primarily when political divisiveness occurs, can always cause significant uncertainty in the financial markets. As a result, the markets become more volatile as investor sentiment starts changing. Not only that but also how the economy as a whole could be impacted by the results and the different policy issues of each candidate.
During these times, investors tend to withdraw from more volatile assets, such as stocks, in the event of an uncertain election outcome or policy issue that can possibly negatively impact the stock. This is why many investors seek out safe-haven assets such as government bonds, which are known to be less volatile during certain political events.
This cautious approach by investors indicates the careful considerations they take into account when making investment decisions during election seasons.
Policy Changes and Their Effects on Various Market Sectors
Changes in government leadership can result in adjustments to fiscal and monetary policies, which in turn can affect different market sectors. For example, a pro-business administration might support specific industries such as financial services and technology.
Conversely, a government with an environmental approach could encourage growth in green energy production.
The changes that the newly elected government could implement could bring about short-term volatility. However, they could also create a longer-term trend in those industries affected the most, requiring investors to readjust their investment strategy.
Measurement Tools for Election-Driven Volatility
VIX as the Market Fear Barometer
The VIX, also known as the “fear gauge,” measures the expected market volatility of S&P 500 options prices over the next 30 days. It generally rises during election season, significantly increasing in the two months following the election date.
During these political events, investors tend to incorporate the VIX into their strategy as they look for possible opportunities while evaluating the potential impact on the financial markets from the election results.
The VIX represents market sentiment, in other words, concerns and fears about risk and uncertainty amid political events and changes. The more fear among market participants, the higher the VIX will go. Conversely, the VIX will move lower if market participants have more optimism.
Analysing the 2020 US Presidential Election and Market Reactions
The 2020 presidential election was a good indication of the type of fear and uncertainty that could occur in the market, not only because of the election but also because the world was experiencing a pandemic.
The market was in a state of panic, and with the uncertainty of possible tax rises, healthcare changes, and trade policy adjustments, the market volatility elevated to a new level of unpredictability.
During these two significant events, the fix reached an all-time high of 85.47.
The Impact of Elections on the Forex Market
Forex Market Fluctuations and Safe-Haven Currencies
During election seasons, we generally see increased demand for safe-haven currencies like the Swiss franc and Japanese yen as investors look to lower their risk exposure.
Currency rates can fluctuate significantly in response to political events, especially regarding a possible leadership transition in a large economy such as the US. This is because exchange rates mimic the market’s response to heightened volatility and fear.
Emerging Markets and Exchange Rate Policies
Political events, such as a presidential election, in larger economies such as the US, the Eurozone, or Japan could significantly impact their currencies. Investors tend to withdraw their funds from developing markets when political events such as these occur, which could cause a currency devaluation and higher borrowing rates.
That said, this will all depend on the overall market sentiment, whether positive or negative.
The way these economies interconnect indicates that such events can create a ripple effect, which could ultimately affect investor sentiment and economic conditions. Gaining a better understanding of the relationship between these developed countries is crucial for investors looking to manage potential opportunities and risks during election seasons.
The Impact of Elections on the Equity Markets
Sectoral Winners and Losers During Election Periods
Elections can greatly impact various industries, causing different reactions depending on the overall market sentiment. For example, equities in the solar and wind power industries may rise, whereas the fossil fuel sector could face some challenges if a candidate who supports renewable energy wins.
This dynamic illustrates how political outcomes can shape investor sentiment and their impact on specific market sectors. Thus, investors must stay informed about election-related developments and their possible effects on different industries.
The Global Ripple Effect from Elections
International equity markets are heavily impacted by presidential elections in countries such as the US, which is also a key player in the global economy.
The results from the US presidential elections can influence the stock market domestically and globally, leading international investors to pay close attention to each candidate's implications for trade and economic policies.
Managing Economic Uncertainty During Elections
Elections can bring both challenges and opportunities for investors.
Understanding how political uncertainty and possible policy changes can affect the financial markets could assist investors in making decisions during election seasons. Tools such as the VIX can offer valuable insight into market sentiment, which could help investors navigate high market volatility.
In addition, staying informed about possible policy changes and their impact on various market sectors could help investors manage their assets and assist in their overall decision-making process about specific opportunities that could arise.
