Why stock markets are volatile during election results

Stock markets are known for their sensitivity to various factors, including economic indicators, geopolitical events, and corporate earnings. However, one of the most significant events that can lead to heightened volatility in the stock markets is the outcome of elections. Whether it's a presidential election, congressional elections, or other significant political votes, the uncertainty surrounding the results and their potential impact on policy can lead to significant market swings. This blog will delve into the reasons why stock markets are particularly volatile during election results.

Understanding market volatility

Before exploring the specific reasons for election-induced volatility, it is essential to understand what market volatility is. Volatility refers to the rate at which the price of securities increases or decreases for a given set of returns. High volatility means that the price of a security can change dramatically over a short period, leading to significant market swings. Market volatility is often measured by the VIX Index, also known as the "fear gauge," which tracks the market's expectations of volatility based on S&P 500 index options.

Factors contributing to market volatility during elections

1. Uncertainty

The primary driver of market volatility during elections is uncertainty. Investors and market participants generally prefer stability and predictability. Elections introduce a significant degree of uncertainty because the outcomes are not known in advance, and different candidates or parties may have vastly different policies that could impact the economy and specific industries in various ways.

• Policy Changes: Different political parties and candidates often have different approaches to taxation, regulation, government spending, and trade policies. For example, one candidate might promise tax cuts for corporations, while another might propose higher taxes. These potential policy changes can significantly affect corporate profits and investor sentiment.
• Economic Direction: Elections can determine the future direction of economic policy. For instance, one party might favour stimulus spending to boost the economy, while another might focus on reducing the national debt. These differing approaches can lead to uncertainty about the future economic environment.

2. Market Reactions to Polls and Predictions

In the lead-up to an election, markets often react to polls, predictions, and debates. As new information emerges, market participants adjust their expectations about the likely outcome and the potential impact on various sectors.

• Poll Fluctuations: Frequent changes in poll results can lead to market swings as investors react to the perceived likelihood of different outcomes. A candidate gaining or losing ground in the polls can cause market optimism or pessimism, respectively.
• Debates and Campaign Developments: Key moments in the campaign, such as debates or significant policy announcements, can influence market expectations. For example, a candidate performing well in a debate might lead to a surge in market confidence, while a scandal or controversy might cause market jitters.

3. Historical Precedents and Investor Sentiment

Historical precedents also play a role in market volatility during elections. Investors often look to past election cycles to gauge how the markets might react to current events. This historical context, combined with investor sentiment and behavioural biases, can amplify market movements.

• Historical Patterns: Investors may analyse past elections to identify patterns or trends. For instance, some investors believe that markets tend to perform better under certain political parties, leading them to adjust their portfolios accordingly.
• Behavioural Biases: Investor behaviour is influenced by psychological factors. The fear of missing out (FOMO), herd mentality, and overreaction to news can all contribute to increased volatility during election periods.

4. Market Speculation and Trading Volume

The uncertainty and anticipation surrounding elections often lead to increased trading volumes and speculative activity. Investors might engage in more short-term trading, trying to capitalise on expected market movements based on election outcomes.

• Increased Trading Volume: Higher trading volumes can lead to greater price swings as buy and sell orders flood the market. This heightened activity can amplify volatility.
• Speculative Trading: Speculators might take positions based on their predictions of election outcomes, leading to significant market movements as they react to new information.

5. Impact on Specific Sectors

Different sectors of the economy may react differently to election results based on the policies proposed by the winning candidates or parties. This sector-specific impact can contribute to overall market volatility.

• Healthcare: Proposals for changes to healthcare policy, such as the introduction of public healthcare options or modifications to existing programs, can lead to significant volatility in healthcare stocks.
• Energy: Energy policies, including stances on fossil fuels, renewable energy, and environmental regulations, can impact energy sector stocks.
• Finance: Financial regulation and tax policies can affect the profitability and operations of banks and financial institutions.

Conclusion

Elections are a critical event that can significantly influence stock market volatility. The uncertainty surrounding election outcomes, the potential for significant policy changes, market reactions to polls and predictions, historical precedents, increased trading volumes, and sector-specific impacts all contribute to heightened market movements. If you invest in stocks, you need to be aware of these factors and consider them when making stock investment decisions during election periods. While volatility can present risks, it can also offer opportunities for those who are prepared and able to navigate the turbulent market conditions.