Despite a meaningful lead in national polls by former Vice President Biden over President Trump, the next President of the United States will be decided by the outcome in approximately 13 states. As of November 2, more than 91.6 million ballots have been cast, representing around 67% of the total 136.5 million ballot cast in the 2016 presidential election (source: CNN). The number of early and mail-in ballots cast so far dwarfs the number of mail-in ballots cast in 2000, the year of the last contested presidential election between former Vice President Al Gore and then Governor George W. Bush. Currently 13 states, including the swing states of Michigan, Pennsylvania and Wisconsin, do not tabulate mail-in ballots until election day. Moreover, recent rule changes in North Carolina and Wisconsin mean that ballots received after the election (but post-marked before it) are still accepted. On November 2, a federal judge rejected a Republican-led petition to invalidate 127,000 ballots cast via drive-through voting stations in Harris County, Texas (source: CNBC). The larger concern is that in a number of battle-ground states President Trump may appear to have won on election night but, after mail-in votes (that appear to be predominantly Democrat supporting) are counted over the following days, the states’ electoral votes will move into the Biden camp. Additionally, in some states (for example, Pennsylvania, and Wisconsin), the governorship and the legislature are controlled by different parties, and each might send a separate slate of electors to Congress on January 6th. The procedures for what happens then are complicated – but the dispute would invariably drag on and the ultimate result will be considered illegitimate by a sizable percent of the U.S. population.

What Are Investors Discounting?

Betting markets are increasingly discounting a so-called Blue Wave (Chart 1 and Chart 2). As Vice President Biden’s lead over the President has increased, particularly in key swing states, market participants have accordingly been discounting the risk of a contested election. According to a survey of investors and corporate clients by Evercore ISI earlier this week, 76% of respondents anticipated clarity on the winner within a week of Election Day, up from 63% two weeks ago (Chart 3). Accordingly, options markets have steadily reduced event risk priced around the U.S. presidential election across a wide range of global assets (Chart 4).

While a clear election outcome on November 3rd would obviously reduce the risk of a contested election, we believe that the market may be underappreciating the risk of civil unrest that even a week’s delay in determining the outcome may foster. In other words, the market relevant risks are not the fact of a contested election, but the second and third order adverse responses to it.

Even if current polling suggesting a Biden win and/or a Blue Wave prove to be accurate, three factors could exacerbate the risks of civil unrest:

  1. Presidential rhetoric that has consistently casted aspersions on the legitimacy of the electoral process. The President has been particularly focused on undermining the authenticity of mail-in ballots (which received political wisdom posits to be more Democratic) and casted aspersion on the likely possibility that the results of the election will be determined well after November 3rd, as we await the tabulation of mail-in ballots. The last time the U.S. faced a disputed election, Al Gore’s acceptance of the Supreme Court’s ruling, which led to the election of his political opponent, helped to heal the hyper-partisan fissures that could easily have devolved into a dangerous cascade of partisan recriminations. By contrast, President Trump’s rhetoric raises the risk that he would attempt to delegitimize the results, in today’s seemingly more dangerously partisan environment. When asked in the first presidential debate whether he would commit to a peaceful transfer of power, Trump responded: “We’re going to have to see what happens. You know that I’ve been complaining very strongly about the ballots, and the ballots are a disaster”.1 Another non-negligible risk (which is not being discounted) is that if defeated, a frustrated President Trump could easily dish out negative surprises, particularly on China relations, until he leaves office on January 20.
  2. More widespread electoral disputes and broader public focus. Relative to the 2000 election, where the focus was on perceived voting irregularities in one state, the geographical footprint of disputed states this time around could be broader. Moreover, a contested election today would play out well beyond the echo chamber of political, media and legal insiders in 2000 to a broader segment of the population, whose anxiety may be more heightened by both the pandemic and any manifestations of recent high-profile threats of an armed response by certain radicalized groups.
  3. The extreme hyper-partisanship of the current media broadcast and social media landscape. Unlike the 2000 election, many Americans receive their news and perspective on current events through partisan echo-chambers that are remarkably divergent. Should there be a disputed outcome, these media outlets could exacerbate each party’s suspicions of being “cheated”.

With respect to anticipated market outcomes, history provides few useful analogs to estimate the response of financial assets. Contested presidential elections that disputed the legitimacy of the outcome have only occurred twice in U.S. history: the 1876 election between Republican candidate Rutherford B. Hayes vs. Democrat Samuel J. Tilden, and the 2000 election between former Vice President Al Gore and then Governor George W. Bush. Unfortunately, the 36 disputed days of the 2000 election, (when the S&P 500 index fell by 5%, non-U.S. equities fell by 3.2%, ten-year treasury bonds rose by 3.45% and the U.S. dollar slightly declined), are an imperfect analog. As noted previously, Al Gore’s acceptance of the court ruling curtailed both political uncertainty and market volatility. Moreover, bond yields in early November 2000 were above 5% vs. today’s level of .74%, thus theoretically providing less asset protection. On the other hand, despite the strong post March rally in U.S. share prices, P/E ratios today are slightly lower (22x earnings vs. 27.6x earnings in early November). For investors that have the flexibility, safe haven currencies, options and futures are likely to provide a hedge against such volatility. While richly valued, gold is also typically a haven in times of uncertainty; however, it also has an inverse relationship with the countercyclical U.S. dollar and real yields.

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