Wall Street is ‘doomsday prepping’ for the election. It might not be necessary

The first presidential debate of 2020 didn’t exactly scream “peaceful transfer of power.”

If anything, the debate debacle and President Donald Trump’s false claims of a “rigged” election, underscore why investors have been bracing for election-related market turbulence.

The winner may not be known for days or weeks — and even then, the election could be contested. That’s the nightmare scenario Wall Street wants to avoid.

Democratic presidential candidate and former Vice President Joe Biden gestures while speaking at the Constitution Center in Philadelphia, Sunday, Sept. 20, 2020, about the Supreme Court. (AP Photo/Carolyn Kaster)

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“It was chaos,” Kristina Hooper, chief investment strategist at Invesco, said of the debate. “I walked away from last night thinking there is an even greater chance of a contested election.”

Many expected a messy debate. It certainly was.

“It seems as though a dumpster fire of a year produced a dumpster fire debate,” Ed Mills, Washington policy analyst at Raymond James, wrote in a note to clients.

Chris Krueger of Cowen Washington Research Group argued that characterization is charitable. “By definition, dumpster fires are contained,” Krueger joked in a client report.

But some wonder if the election pessimism on Wall Street is overdone. The risk of chaos may already be priced in.

Investors hardly panicked even after a debate that was widely slammed as a national embarrassment. After initially retreating overnight, the Dow opened solidly higher and was recently up 350 points, or 1.5%, on hopes of fiscal stimulus.

Keep in mind that markets tend to freak out when they’re caught off guard by a shock (like a pandemic or financial crisis). But nothing here should be a surprise at this point. For months, futures contracts linked to the VIX volatility index have indicated investors are buying insurance against market turmoil around the election. Goldman Sachs and others flagged this phenomenon back in early July.

What could ‘catapult markets higher’

If many investors have been bracing for the worst, markets could react quite positively if the nightmare doesn’t arrive.

Charlie McElligott, a cross-asset macro strategist at Nomura Securities, argued in a Tuesday afternoon report that the scenario that is “underpriced” by volatility markets is “one where this ‘extended chaos’ scenario does NOT realize.”

He pointed to the potential for an earlier-than-expected conclusion to the election or a “large, clear-cut Biden electoral win.”

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This risks a situation where all the “doomsday prepping” by investors needs to get rapidly unwound, McElligott wrote, an outcome that could “catapult markets higher.”

That’s despite the fact that a Biden win, coupled with the Democrats flipping the Senate, would cause concern about higher taxes and increased regulation.

McElligott said that his analysis shows the risk of a “‘crash-UP’ as rather surprisingly more pronounced than ‘crash-DOWN.’”

One of the major uncertainties is how long it will take to count the surge of mail-in ballots that is expected because of the pandemic. Some states don’t even begin that process until Election Day. Others accept mail-in ballots received after Election Day if they are postmarked by a certain date.

But Mills, the Raymond James analyst, has pointed out that key battlegrounds like Arizona and North Carolina can count mail-in ballots before Election Day — and those results could telegraph the winner to markets.

“The outcome may come quicker than the prolonged process that is feared,” Mills wrote.

Why this election is different

Of course, no one knows for sure how this will turn out.

There are very legitimate reasons for investors to be more concerned about a contested election.

At the top of the list is Trump’s repeated efforts to spread disinformation about mail-in voting and baseless “rigged election” claims.

“They’re sending millions of ballots all over the country,” Trump said. He added: “This is going to be a fraud like you’ve never seen.”

Those comments, and similar ones made by Trump during the debate, raise questions about a peaceful transfer of power.

President Donald Trump leaves after speaking about coronavirus testing during an event in the Rose Garden of the White House, Monday, Sept. 28, 2020, in Washington. (AP Photo/Evan Vucci)

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“We’ve been very blessed in presidential elections,” said Invesco’s Hooper. “Even in 2000, when it was unclear what the outcome was, it was orderly and civilized. There is a fear that it might not be this time. And that could fuel more volatility and selloffs.”

More than anything, investors are just hoping for a clear, undisputed winner. And if that happens, sooner rather than later, it could set off a knee-jerk rally on Wall Street.

“That sound you’d hear,” Hooper said, “would be the exhaling of many, many investors everywhere.”