Stocks reaction to presidential debate a warning against mixing politics and portfolios

The U.S. stock market didn’t zoom off to the races after Donald Trump appeared to best President Joe Biden in Thursday’s presidential debate. Still, market participants may be increasingly anticipating, and welcoming, the prospect of a Trump victory.

That anticipation may or may not prove correct in what remains a tight race between two unpopular candidates. History indicates that investors should work to separate any partisan enthusiasm or disdain from their portfolio choices, particularly as the battle for the presidency goes through its usual twists and turns.

Election season “tends to be a very emotional time and people tend to make emotional decisions,” Keith Lerner, chief market strategist at Truist, told MarketWatch in a phone interview. “Other factors matter more.”

See: 5 stock-market takeaways as Biden sees ‘incredible pressure’ to step aside after debate

Stock-index futures, the dollar and other assets rose in overnight trading following Thursday’s presidential debate, which saw a halting performance by Biden. Trump looked more composed but leaned into falsehoods about the economy, the Jan. 6, 2021 attack on the Capitol and other issues. Biden’s shaky performance sparked alarm among Democrats and speculation the president could step aside for another candidate before the Nov. 5 election.

In One Chart: Betting markets put Biden’s chance of re-election at new low, while Newsom gains

The overall market reaction, however, was muted. The S&P 500 index and Nasdaq Composite finished lower Friday, after flirting with records. The Dow Jones Industrial Average also finished slightly lower. The rally lost steam as a Treasury rally, which pulled yields down, reversed, pushing yields back to the upside, with some traders blaming worries over the prospect of burgeoning government budget deficits.

Check out: Bond market participants brace for bigger fiscal deficits under either Trump or Biden

That said, gains for the dollar and stock futures in the immediate aftermath of the debate do suggest growing market confidence in a Trump victory, said Solita Marcelli, global wealth management chief investment officer for the Americas at UBS, in a note.

Expectations a Trump administration redux would maintain or even deepen corporate tax cuts while also cutting regulations are often cited as reasons for a positive market reaction to Trump’s prospects.

Jeff deGraaf, chairman and head of technical research at Renaissance Macro Research, noted Friday that the negative correlation between Biden’s standing in the polls and S&P 500 index performance, while not statistically significant, does a better job than any other factor, including oil prices, Treasury yields, Federal Reserve policy, corporate bond spreads, purchasing manager index readings, inflation data and gross domestic product, of explaining stock-market performance (see chart below).

The data “offers a glimpse to some as to why equities (SPX) have been so inexplicably firm for 2024,” he wrote, adding, “We have always maintained (and continue to believe) that a bearish narrative based off of a U.S. political candidate is a bad bet fueled more by ideological hysteria and less on sober analysis, historical facts or belief in the ingenuity of the human spirit.”

Indeed, Marcelli noted academic research shows political affiliation directly affects optimism regarding the future direction of the economy.

“This partisan bias is a dangerous element for investors, especially in a politically charged election year, threatening to override one’s objective assessment of risk and potentially skewing investment behaviors,” she wrote. ”While the election will be consequential, the U.S. political outcomes are far from the largest drivers of global economic growth and financial market returns.”

Corporate earnings and economic growth expectations have been the real key to the stock-market rally off the October lows from last year, Truist’s Lerner told MarketWatch. At the beginning of the year, expectations for the economy and earnings were too, he said, while they’re now better calibrated to Truist’s expectations, he said.

Meanwhile, the stock market’s strong 14% gain over the first half of 2024 would appear to bode well for the rest of the year regardless of the twists and turns of the presidential campaign. Since 1950, there have been 23 years, not counting 2024, in which the S&P 500 rose 10% or more in the first half. Stocks went on to further gains in 19 of those 23 years, producing an average second-half gain of 7.7%, Lerner noted.

And analysts have noted that presidential election years have also tended to be positive for stocks, including the stretch from June to October. The stock market tends to rally once an outcome is clear, but can be prone to bouts of volatility as election day nears when the battle is close fought.

Lerner said investors should be prepared for that possibility. Longer term, he said, it’s important to note that stocks have performed well and consistently, posting annualized returns of 12% to 15%, under the last three presidents.

Politics and policy certainly matter, he argued, but in the end, the path of inflation, interest rates and whether the Federal Reserves can guide the economy to a soft landing will likely end up being more important.