What Impact Do Elections Have on Financial Markets?
Elections can have significant power over financial markets, both immediately and over time.
This sway is due to the potential economic consequences of the policy proposals from different candidates/parties and other factors we’ll cover.
And financial markets and economies also have sway on election outcomes (i.e., an underperforming economy may increase the likelihood of a change in leadership).
Key Takeaways – Elections & Financial Markets
- Elections influence markets via various policy changes, foreign relations, and other knock-on effects.
- Market reactions anticipate policy impacts, discounting candidates’ win probabilities, feasibility of their plans, and potential policy outcomes.
- Policies, like tax changes and government spending, impact investor expectations and sector movements.
- While markets might react immediately to an election outcome, the long-term effects might differ based on the actual policy implementations of the elected government.
Money and Credit Flows
One of the most evident ways elections impact markets is via their influence on money and credit flows based on:
- their stated policy proposals
- the credibility of their policy proposals
- the likelihood of them being implemented (and for how long)
Government spending or taxation promises can influence investor expectations about future economic activity, which then flows into market movements.
For instance, promises to invest heavily in infrastructure might boost construction, materials, and related sectors, and yield a longer-term productivity boost.
Or, if a candidate wants to lower corporate taxes, it’s generally favorable for the stock market because companies become worth more if they can retain more of their earnings.
However, if these promises also raise concerns about ballooning deficits or inflation (in the case of higher spending), they might have a mixed or even negative impact on broader market indices.
Traders often look beyond the headline promises to gauge the feasibility and broader economic implications of such spending commitments or proposed tax policies.
Sentiment
Elections also shape “sentiment,” which, in turn, can drive market movements.
Perceived Policy Impact
If policies are perceived to potentially harm the value of businesses, investors might be hesitant to allocate more money in stocks, precipitating a dip in stock prices.
Volatility
Elections often result in increased market volatility, especially in the run-up to the election day and immediately after the results are announced.
Market Discounting
The potential of a candidate winning is discounted into markets far ahead of the actual election(s) and declaration of a winner.
This process also discounts the likelihood of their policies being enacted, and the subsequent effects on the money and credit flows that determine prices in markets.
For example, if one candidate wants to raise taxes and the other wants to lower taxes, markets will discount their probabilities of winning in conjunction with the feasibility of their plans being passed into law, and the impact those would have.
A candidate promising favorable economic policies for businesses, for instance, might see a stock market rally in anticipation of their victory.
Conversely, a candidate promising tighter regulations, higher taxes, or increased unionization of workers might see the stock market fall, as traders/investors calculate the proposed effects of those policies.
Short-Term vs. Long-Term
Short-term market reactions to election outcomes often reflect immediate investor beliefs, which can be driven by surprise, relief, concern, or indifference about the result.
However, these initial responses can be ephemeral.
Long-term trends are more influenced by the actual implementation of policies and their sustained impact on the economy.
Flow of Foreign Investments
Depending on the perceived business climate after elections, there might be an inflow or outflow of foreign investments.
Social and Civil Stability
Election results can sometimes lead to social unrest or demonstrations, particularly if the results are controversial.
Such instability can negatively impact markets.
Corporate Decision-making
Companies may delay or accelerate certain strategic decisions based on expected policy changes following an election.
Consumer Confidence
The economic outlook perceived by consumers post-election can influence their spending and saving patterns.
Speculation
Traders/investors might attempt to anticipate election outcomes and make speculative bets.
This can add another layer of market movement.
Comparative Global Standing
How a country’s election is perceived internationally can influence foreign exchange markets and international investments.
Policy Impacts on Markets
Several policies can directly influence money and credit flows:
Tax Policy
Different political parties might have varied stances on taxation.
The anticipation or realization of changes to tax policies can influence corporate profitability and individual investment decisions.
Tax cuts might spur consumer spending and business investment, and therefore potentially enhance economic growth.
But tax cuts might also generate higher government deficits.
This can, in turn, exert upward pressure on interest rates.
This can lead to lower credit creation, and thus lower spending, less investment, etc.
There are short- and long-run effects, and considerable nuance and unknowns, depending on how the policy is designed.
Government Spending
Changes in government spending priorities, such as infrastructure, defense, or social programs, can have a direct impact on certain industries and the broader economy.
Increased government spending can potentially amplify economic growth, but also result in higher deficits and higher inflation.
It depends on the nature of the spending and whether it has the ROI that is high enough to service the debt.
Many programs – like education, infrastructure, and research – have long lead times, though they can be very beneficial if the productivity gains justify the costs.
Perception about fiscal policies can impact bond markets and, subsequently, influence interest rates.
Trade Policy
The stance of elected leaders on trade agreements, tariffs, and international relations can directly impact multinational corporations and the broader trade balance of a country.
Trade conflicts can disrupt the smooth operation of supply chains, raising operational costs for businesses.
The outcome is often a decelerated economic growth and steeper prices for consumers.
However, when countries are having more conflict, trade is often one of the first dominoes to fall as countries try to become more self-sufficient.
Regulation
Depending on the political platform of the incoming party or leader, there may be potential changes in regulations that can impact specific sectors like healthcare, finance, energy, and technology.
While ensuring a safer financial ecosystem, stringent regulations might also increase costs for businesses and could impair innovation.
However, preventing capital misallocation (e.g., strict punishment for fraud) and prudently increasing safety (e.g., sufficient capital cushions for commercial banks) can lead to more stable markets and economies.
Monetary Policy
Although central banks typically operate independently from politics, the appointment of central bank officials or the political pressure on monetary policy can indirectly affect market expectations.
Decisions on interest rates and other forms of monetary policy can drastically affect money and credit flows.
An uptick in interest rates can render borrowing costlier for businesses, potentially hampering economic growth.
But higher interest rates are generally needed when there are inflationary pressures in an economy to avoid those pressures from impacting productivity.
Foreign Relations and Geopolitical Risks
The diplomatic approach of elected leaders toward other countries can lead to changes in geopolitical risks, which can influence markets.
Structural Reforms
Elections can lead to structural economic reforms which might be viewed positively or negatively by the markets.
Sector-specific Impacts
Depending on campaign promises and policy stances, certain sectors might benefit or be disadvantaged.
For instance, a promise to invest in renewable energy might boost the green energy sector.
FAQs – What Impact Do Elections Have on Financial Markets?
How do elections influence stock market performance?
Elections introduce elements of potential change in policy direction.
As traders/investors react to these unknowns, stock market volatility can increase.
The introduction of new policies, fiscal agendas, and leadership can lead to market shifts.
Do financial markets prefer certain political parties over others?
Financial markets don’t inherently prefer one political party (or side) over another.
It’s more about the policies and their anticipated economic effects than the party itself.
However, markets often respond to the specific economic policies associated with a particular party at a given time.
For instance, a party advocating for deregulation might be viewed favorably by certain industries, leading to positive market reactions in those sectors.
One party may not be “good” or “bad” for the stock market monolithically.
For example, the traditional energy vs. alternative energy dichotomy is well-known.
Political parties also evolve over time, as do government types.
How does investor sentiment shift during election seasons?
Uncertainty about election outcomes and potential policy shifts can lead to more conservative investment or trading decisions.
However, as election outcomes become clearer, investors may either pull back or become more assertive depending on the anticipated economic and financial implications of the election results.
Why do markets move ahead of elections?
Policy anticipation is a significant driver of market movements before elections.
As traders/investors try to predict the potential economic effects of proposed policies, they adjust their portfolios accordingly.
For instance, if a leading candidate promises to support renewable energy, stocks in that sector might see a surge in anticipation of favorable policies.
How do foreign elections impact global financial markets?
Foreign elections can have ripple effects on markets, especially if the country in question is a major economic player.
Changes in trade policies, diplomatic relations, or economic strategies in one country can affect its trading partners and global industries.
For instance, elections in countries with major currencies, like the US or EU member states, can impact global currency exchange rates and trade relations.
Are there specific market sectors more sensitive to election outcomes?
Yes, certain sectors are more directly affected by political decisions.
For example, energy sectors may be sensitive to policies on environmental regulations, while healthcare stocks might respond to changes in healthcare policies.
Defense and infrastructure sectors could react to changes in government spending priorities.
Consumer staples, however, tend to be less affected.
The sensitivity of sectors largely depends on the specific policies of the elected party or candidate.
How do monetary policies change post-election, and what is their effect on markets?
Monetary policies can either remain consistent post-election or change based on the incoming data or goals of the new administration.
For instance, an administration aiming to stimulate economic growth might advocate for lower interest rates.
While central banks are normally independent, elected officials can determine who will be the ones pulling the levers at the central bank.
Such changes in monetary policies can influence lending rates, investment behaviors, and overall market performance.
What historical trends can we observe about elections and their impact on markets?
Historically, markets tend to experience increased volatility in the run-up to elections, followed by stabilization post-election.
Over longer periods, market performance has often aligned more with global economic conditions, technological advancements, and major geopolitical events than with specific election outcomes.
However, significant policy shifts resulting from elections can lead to notable market reactions.
How do trade wars initiated during election campaigns affect the economy?
Trade wars can introduce tariffs and trade barriers, disrupting global supply chains.
This can lead to increased costs for businesses, potentially resulting in slower economic growth, inflationary pressures, and strained diplomatic relations, all of which can impact financial markets.
Are market reactions to elections based more on perception or actual policy changes?
Both play a role. In the short term, market reactions are often driven by perceptions, sentiments, and speculations about potential policy changes.
In the long run, however, the actual implementation, effectiveness, and consequences of these policies have a more pronounced effect on markets.
Markets discount forward.
So there’s always an element of “guessing” what will happen, and then what transpires relative to what’s priced in.
How do interest rates typically respond to election outcomes?
Interest rates can be influenced by fiscal policies championed by newly elected leadership.
For example, if an administration plans to increase government spending, it might lead to higher interest rates if the government borrows more and it leads to more spending relative to production (due to higher inflation).
Conversely, policies aimed at fiscal consolidation might have a dampening effect on interest rates.
And as mentioned, central banks, which set interest rates in many countries, typically operate independently of political cycles.
Conclusion
While elections can significantly impact markets, they are just one of many factors.
Markets are influenced by a huge variety of domestic and international events, economic data and indicators, corporate earnings, and other macro and microeconomic factors.