How Might the Markets React to Election Day?

Election Day is here and America is holding its breath waiting for the answer to a question with lasting impact for all of us: What will our 401(k)s do on Wednesday?

In recent weeks, I’ve repeatedly been asked, “Should I sell everything, and reinvest once the election is over?” Regardless of what happens at the polls on Tuesday, cashing out completely then trying to buy back at the perfect time is always a fool’s game.

Keep in mind: The stock market (S&P 500) has correctly predicted the U.S. presidential election with 86 percent accuracy over the past 88 years. It’s identified every winner since 1984.

If the stock market is up during the three months prior to the election (Aug. 8 until Election Day), the incumbent party candidate wins. Market down for the three months leading up to the election? The non-incumbent party wins. From Aug. 8 until Nov. 3, the S&P 500 shows a -4.22 percent loss. This would seem to signal a non-incumbent party win, i.e. Donald Trump.

But that doesn’t square with recent polls pointing toward a Hillary Clinton win. The consensus view among political professionals is that we’ll see a relatively close race with Clinton slightly favored to grab the White House.

The stock market as a whole doesn’t necessarily have a favorite candidate. In fact, from a policy standpoint, how can the market know what to think? There has been very little discussion of economic policy during this campaign. But the market does favor certainty, and likes what it already knows. Most would agree that a Clinton presidency wouldn’t bring dramatic change to Washington. Trump as president is a much bigger unknown. This explains why the market often went up when Clinton enjoyed a spike in the polls.

But back to your 401(k). Here’s what is likely to happen depending on who wins on Tuesday:

A Trump win

A Trump win would likely send the market lower in the immediate term, simply because it expects a Clinton victory and the predictability that would provide. Markets would have to quickly reprice to a very new status quo. Remember what happened after the United Kingdom voted to leave the European Union earlier this year? Global markets were pricing in a U.K. vote to stay. When that didn’t happen, stock markets all around the world dropped between 4 percent and 12 percent within a few trading sessions. Most markets did, however, recover those sharp losses in a matter of weeks. I wouldn’t be surprised if something similar played out in a post-Trump victory world.

A Clinton win

In this case, we likely see a stock market relief rally. The market says, “OK, we know what we’re getting. Good or bad, we know what this picture looks like.” This outcome allows investors to quickly turn their focus back to what’s happening in the economy and earnings picture for companies in the U.S. There won’t be a big adjustment period to work through, and markets can quickly go back to evaluating the known fundamentals that drive markets.

And, as of now, fundamentals for the economy and stocks look pretty decent. We have continued to add new jobs at a healthy clip, investment in the broad housing market continues to grow, and earnings (the mother’s milk of stock market returns) have just recently perked up after nearly a year and a half. To date, more than 70 percent of companies that have reported earnings for the third quarter have beat profit expectations, and more than 50 percent have exceeded revenue expectations. What’s more, 2017 earnings are expected to rise at a low double-digit pace.

Election and debate highlights are interesting, and capture the day. Important headlines, like earnings and economic growth, carry the day.

Remember that no matter what happens Tuesday in voting booths, the smoke will clear. And any short-term volatility will ultimately be a buying opportunity for smart, long-term investors.

Read the original AJC article here.

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