Exuberant markets normally favor the incumbent and normal incumbents do whatever they can to support the market. But this is the kind of year when norms get broken.
Ask investors about an election or any other looming event and depending on the questions you’ll get two separate answers.
Some will say what they expect will happen. Others will say what they want to happen. And because the market itself reflects what investors expect, you don’t really have to poll to get that piece of the answer.
Right now, the market supports a scenario where Donald Trump wins a second term. We know this because when stocks go up, history usually favors the incumbent.
It’s going to take a lot of pessimism over the next three weeks to push stocks down over the period that matters.
We know this because the market supports futures trading. Some of the smartest people around have deployed vast resources to weighing the odds and pricing each sliver of probability.
All that effort says Biden loses. Or at least, that’s where the risk-return profile has attracted the real money. Whether that’s what Wall Street actually “wants” is another story.
Polls and puts
Unwinding the Trump bet starts with data LPL compiled showing that as long as the S&P 500 gains ground in the three months leading up to an election, the incumbent party wins 85% of the time.
The numbers go back to 1928 so the entire range of economic scenarios is included here: boom, depression, war, innovation, struggle and unity.
And when the S&P 500 falters in that three-month period, the incumbent loses 89% of the time. While there are exceptions on both sides, the odds definitely favor a correlation between reelection and the market’s mood.
Since an S&P 500 futures contract conveniently expires on November 2, we can even estimate where the market anticipates going by the time the votes come in.
As of today, the weight of capital says the S&P 500 will at worst drop to 3,330 before that contract comes due. The index closed below that point on August 3, so that’s a three-month win for investors and statistically a four-year win for Trump.
In a world where voter polls consistently point the other direction, the divergence is striking. Nate Silver only gives Trump 14% odds to pull out a win. Even the amateur political markets make Biden a 60% favorite.
Unless futures markets are weighing the probabilities too conservatively, Wall Street says Trump’s chances are at least double what he’s getting anywhere else. Unless he’s Jimmy Carter, no sitting president in our lifetime has ever lost the White House under these market conditions.
Of course, the futures market gets it wrong all the time. When consensus expectations get too far removed from reality, contrarians win big.
But if you’re looking for what the investment community expects right now, you don’t need to run any polls. The answers are right there in the data.
And while talk is cheap, these answers are backed up with billions of dollars. Wall Street simply doesn’t believe the market can move far enough in the next three weeks to rock Trump’s incumbent advantage. This is the safe money.
Causation and correlation
Needless to say, LPL’s indicator is really all about economic confidence. The S&P 500 doesn’t have any causal link to the way people vote.
A strong economy makes people happy with the status quo. If the world isn’t broken, voters see less reason to motivate change in the government.
Normally a strong economy gives stocks what they need to rally or at least hold on in an election year. When politicians are paying attention, they’ll do their best to support the market.
It’s a virtuous cycle of stimulus, enthusiasm, jobs and wealth creation. Government supports business. Business supports people and also stocks. People feel rich and support the government they have.
This is not an ordinary year. We are still technically in the most savage economic contraction since LPL’s data set starts in the early Great Depression.
Unemployment is still elevated at late 2012 levels. Corporate profits are still in a place where whole industries are in the early stages of laying hundreds of thousands of people off because they can’t run on hope forever.
While the Fed has worked trillion-dollar wonders to keep the market as a whole within sight of record territory, a lot of people including Jay Powell still say more stimulus is necessary to support businesses and workers alike.
For those people, it doesn’t feel like a boom no matter where the S&P 500 ends up. Jimmy Carter actually presided over what was then Wall Street’s most profitable year ever, but he lost anyway.
Stocks weren’t soaring in 1980 because people were happy or optimistic. The market was an inflation hedge, a way to shield existing wealth from a deteriorating future.
That’s a rare scenario that I for one hope we never have to live through again. But it happened. And while stocks were up in late 1980, unemployment was rising as inflation choked the economy into recession.
A lot of smart people see inflation ahead unless the Fed finds a way to sterilize its ongoing support, whether Congress decides to spend trillions or not.
Perversely enough, higher taxes would vacuum cash out of the economy and solve that problem at least. Maybe that’s why Joe Biden gets the moral authority to warn his Wall Street backers that a vote for him is a vote against good times ahead.
The rich would pay more, one way or another. Some of the rich are happy with that prospect. Others will fight it. They all get one vote apiece.
Likewise, the poor don’t necessarily vote in their immediate best interest either. Millions don’t pay taxes and keep voting for tax cuts, perhaps in a form of aspirational thinking or outright largesse.
A lot of the people I know on Wall Street and Main Street alike are eager for four more years. A lot are desperate for a change.
Life continues either way
Elections at their purest are when we vote with our ballots and not our wallets to decide who we are as a nation and how we as individuals want to fit into that narrative. That's where the polls come in.
And what’s good for some wallets is bad for others. History is a hard process. After the disruptions of the late 1970s, the U.S. economy needed years to fight off the great malaise, wrestle inflation back into submission and start growing again.
We’re a mathematical industry, arguing with numbers. Let’s see where the numbers go.