Post-Election Analysis: U.S. Election and Portfolio Dynamics for Investors

Elections serve as pivotal events that can significantly influence market volatility, particularly when they are characterized by tight races and high stakes. The recent U.S. presidential election exemplifies this dynamic, as it was marked by intense competition and uncertainty, leading investors to grapple with the potential implications of policy changes and their economic consequences. This environment often results in pronounced fluctuations across various asset classes, reflecting the heightened sensitivity of the markets to electoral outcomes.

This second edition examines the effects of the closely contested election on market dynamics, with a particular emphasis on immediate market reactions and the subsequent backtesting analyses derived from our inference model. By examining these immediate responses, we aim to uncover the implications of electoral outcomes on market behavior, equipping investors with essential insights to adeptly navigate the heightened volatility that frequently accompanies political events.

Introduction

In this edition, we utilize the same set of hypothetical portfolios as in the first edition in this series US Election & Portfolio Dynamics: Insights for Investors, which are primarily composed of equities and fixed-income securities. These portfolios serve as a foundational framework for evaluating the potential impacts of the recent U.S. presidential election under various market conditions.

We employed the shocks observed 1-day post-election as inputs to the inference stress test, projecting the portfolio returns under multiple scenarios, including fluctuations in interest rates, foreign exchange rates, credit spreads, and equities. This approach allows us to assess how immediate market reactions influenced the performance of our portfolios in the wake of the election.

A critical aspect of our analysis involves comparing the projected returns generated from the inference stress test with the realized portfolio returns. By evaluating these discrepancies, we can assess the accuracy of our projections and understand how effectively our models captured the market dynamics following the election.

The analysis focuses on key regions, particularly the U.S. and the EU, to provide a global perspective on the election's impact on financial markets. For instance, we examined how a sudden increase in interest rates might affect fixed-income securities within the portfolios, as well as the potential impact of currency fluctuations on equities that have significant international exposure. Additionally, we evaluated the effects of widening credit spreads, which could indicate increased perceived risk among investors, particularly in the wake of uncertain political outcomes.

By utilizing the 1-day-post-election shocks as inputs, we gain valuable insights into the immediate effects of the election on market dynamics and how these shocks translate into portfolio performance. This scenario analysis not only highlights the immediate impacts of the election but also offers insights into longer-term implications for portfolio management. Understanding these risks and opportunities enables investors to better position themselves to navigate the complexities of a politically influenced market environment.

Market Dynamics Post-Election: The Perceived Tightness of the Recent Election

The recent U.S. presidential election was characterized as one of the closest races in the history of American politics. The New York Times reported that on election day, neither Kamala Harris nor Donald J. Trump led by more than a single percentage point nationwide or across key battleground states.¹ This unprecedented closeness in polling created significant uncertainty among market participants, leading to heightened volatility in the financial markets.

Figure 1: Pre-election poll results from The New York Times.

When election outcomes are uncertain based on pre-election polls, market dynamics can fluctuate dramatically due to the anticipated policies of the winning party. This environment often leads to increased volatility as investors adopt a wait-and-see approach, pausing their trading activities until clearer signals emerge about the future political landscape, as discussed in U.S. Election & Portfolio Dynamics: Insights for Investors.² This caution contributes to lower market activity and heightened price fluctuations.

Following the election, the S&P 500 Index annualized historical volatility saw an uptick the day after the results announcement, while the implied volatility index (VIX) experienced a decline. This contrasting behavior reflects the close nature of the election, which typically heightens uncertainty and risk in the markets. Investors tend to hedge their positions in response to the potential for unexpected outcomes, resulting in increased historical volatility as market movements become more pronounced. However, once the election concluded and a winner was determined, the immediate uncertainty dissipated, leading to a decrease in the VIX, which indicates expectations of future volatility. Implied volatility, derived from the price of options, serves as a forecast of this future volatility. As illustrated in Figure 2, which depicts the S&P 500 historical volatility alongside the VIX index, the dynamics of a tightly contested election resulted in a temporary spike in historical volatility, while the resolution of the electoral process ushered in a more stable outlook, as evidenced by the falling VIX.

Figure 2: Annualized historical volatility of SPX versus VIX. 

Immediate Market Reactions: 1-Day-Post-Election Realized Shocks

The immediate aftermath of the recent U.S. presidential election saw notable shifts across various market indicators, reflecting the dynamic interplay between political outcomes and investor sentiment. The following table summarizes the 1-day-post-election shifts across key indices and financial instruments, illustrating how different sectors and asset classes reacted to the electoral results.

Table 1: 1-day-post-election shifts in key market indicators.

Figure 3: Considered shifts in key market indicators by asset class.

The S&P 500 experienced a robust increase of 2.53%, signaling overall investor optimism and confidence in market stability following the election results. This sentiment was echoed in the S&P 500 Bank Index, which surged by an impressive 10.68%. Such a significant rise indicates strong investor confidence in financial institutions, likely driven by expectations of favorable policies that could benefit the sector.

In contrast, the S&P Clean Energy Index saw a notable decline of 6.08%. This drop may reflect investor concerns regarding the future direction of energy policies, particularly if the winning party's agenda appears less supportive of green initiatives. The mixed performance across sectors highlights the varying expectations investors hold regarding the implications of the election results on different industries.

Additionally, the 2-year and 10-year Treasury yields both increased, suggesting a shift in investor expectations for interest rates and inflation. The rise in yields indicates that investors are anticipating potential rate hikes and a more robust economic outlook in the post-election environment.

Internationally, the EURO STOXX 50's slight decrease of 1.43% suggests that European markets reacted negatively to the U.S. election results, possibly due to concerns over transatlantic relations. Conversely, the EUR/USD exchange rate saw a 1.09% increase, indicating a strengthening of the euro against the dollar, which may reflect shifts in investor sentiment regarding U.S. economic policies.

This overview of immediate market reactions underscores the diverse impacts of election outcomes on financial markets, setting the stage for a more detailed backtesting analysis in the following section.

Backtesting Analysis of Market Reactions: Running Scenarios to Estimate Portfolio Impact

The shocks summarized in Table 1 are integrated into the inference stress testing feature of the Buy-Side Risk Solution by S&P Global Market Intelligence to project future impacts of market shocks on the considered portfolios. The inference stress testing engine processes stress scenarios associated with various risk factors—such as stocks, commodities, and bond market indices—and then evaluates the portfolio's stress profit and loss (P&L) based on historical correlations among these risk factors.

We then compare the projected returns with the realized portfolio returns following the election. This comparative analysis is illustrated in Figure 4, which summarizes the impacts (% MTM) 1 day after the election, categorized by instrument type for selected hypothetical portfolios.

Figure 4: Summary of realized versus projected impacts (%MTM)  1 day after the election. 

The analysis of the realized versus projected returns reveals that the inference model performed particularly well with the U.S. Equity Fund. The fund achieved a realized return of 3.66%, closely aligning with the projected return of 3.48%. This strong performance suggests that the model effectively captured the optimism in the U.S. market following the election results. Investor confidence, buoyed by favorable policy expectations and robust economic fundamentals, translated into a positive outcome that met the model's projections.

Similarly, the Short Duration Bond Fund demonstrated commendable alignment between its realized return of ‑0.04% and the projected return of ‑0.06%. This close match indicates that the inference model accurately anticipated the stability of this fund amidst turbulent market conditions. The fund's defensive positioning, designed to mitigate interest rate risk, proved effective in navigating the uncertainty following the election, resulting in minimal losses that were consistent with projections.

The Global Equity Fund also showed a positive performance, realizing a return of 2.41%, albeit lower than the projected return of 3.90%. This divergence suggests that while global equities benefited from overall market optimism, the actual performance was tempered by volatility and uncertainty surrounding the election outcomes. The model may not have fully captured the recalibration of investor expectations as the political landscape evolved.

In contrast, the U.S. Treasury Fund recorded a realized return of -0.94%, significantly diverging from the projected return of -0.30%. Similarly, the Global Bond Fund experienced a realized return of -1.12%, which deviates markedly from its modest projected return of 0.16%. This underperformance of the model underscores the sensitivity of Treasury yields to fluctuations in interest rate and equity expectations.

The divergence between projected and realized performance can be attributed to several factors, particularly the recent shift in the correlation between equities and bonds. Over the past 2 years, this relationship has transitioned to a positive correlation, breaking a decade-long trend in which bonds typically served as a safe haven during equity market downturns. As illustrated in Figure 5, the correlation between the S&P 500 and the U.S. Aggregate Bond Index began to shift in mid-2022, indicating that these asset classes have started to move in tandem rather than inversely. This observation suggests that utilizing a larger historical window—greater than 5 years—would capture periods of negative correlation, potentially resulting in more accurate projections.

Figure 5: 1-year rolling correlation of daily returns of SX5E, SPX, and U.S. Aggregate Bond Index.

Since the recent U.S. presidential election, the positive performance of equities has contrasted sharply with the negative returns of bonds. This phenomenon is likely due to concerns that inflation will rise if the tariffs proposed by president-elect Trump are imposed, which could lead to increased costs for consumers and businesses alike. In anticipation of the likely inflationary pressures that would result, investors reacted by selling off bonds, which traditionally lose value in inflationary environments while simultaneously drive equity prices higher on the expectation of continued economic growth. The Global Bond Fund's performance reflected this new dynamic, resulting in returns that fell short of projections. The inference model did not fully account for this shift in correlation and the broader implication of inflation concerns on bond performance, leading to a divergence that underscores the complexities of market reactions in a politically influenced landscape.

The EU Equity Fund exhibits a pronounced divergence, with a realized return of -1.95% sharply contrasting with the projected return of 1.24%. This difference can be attributed to the positive historical correlation between U.S. and EU equities, as well as the recent trend of positive correlation between EU equities and U.S. Aggregate Bonds. As illustrated in Figure 5, which presents the 1-year rolling correlation of daily returns between SX5E and SPX, and between SX5E and the U.S. Aggregate Bond Index, these correlations demonstrate how the performance of EU equities is increasingly influenced by movements in both U.S. markets and fixed-income securities. This shift may have contributed to the unexpected underperformance of the EU Equity Fund relative to projections.

In summary, the inference model showed robust performance with the U.S. Equity Fund and the Short Duration Bond Fund, demonstrating its effectiveness in navigating market dynamics. A critical factor in the model's performance is the selection of the appropriate historical window for correlation calculations. The correlations used in the inference model significantly influence the projections, and choosing a window that accurately reflects market relationships is essential for capturing the complexities of investor sentiment and market behavior.

Overall, the insights gained from this analysis affirm the model's potential as a powerful tool for understanding and anticipating market reactions to political events, while also emphasizing the need for continual refinement in the choice of historical correlation windows to enhance the accuracy of results.

Conclusion

The analysis reveals a complex interplay of alignments and divergences between projected and realized returns across various portfolios. Notably, funds concentrated in U.S. equities exhibited remarkable resilience, consistently meeting or exceeding expectations, which reflects strong investor confidence in the domestic market. Conversely, other portfolios, particularly those in the bond and European equity sectors, faced substantial challenges that led to underperformance.

The application of inference models and stress testing empowers managers to translate economic indicators into actionable market risk factors, establishing a robust framework for risk assessment and management. By effectively identifying vulnerabilities and implementing strategic hedging measures, asset managers can safeguard their investments against adverse impacts while seizing emerging opportunities.

These findings highlight the intricate nature of market dynamics in response to political events and emphasize the critical need for careful selection of historical market data used in the analytical model. By improving their capacity to capture the nuances of investor sentiment, asset managers can more adeptly navigate the unpredictable landscape shaped by political developments. As investors seek to comprehend the intersection of politics and finance, understanding these dynamics will be essential for positioning portfolios effectively in an increasingly uncertain environment.

References

¹ The New York Times, “Election 2024 Polls: Harris vs. Trump”. 5 November 2024. https://www.nytimes.com/interactive/2024/us/elections/polls-president.html

² Chraibi MA. “U.S. Election & Portfolio Dynamics: Insights for Investors”. S&P Global Market Intelligence, 16 October 2024. https://www.spglobal.com/market-intelligence/en/news-insights/research/us-election-and-portfolio-dynamics-insights-for-investors

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