Home Economy What Markets Are Telling Us as Election Results Roll In

What Markets Are Telling Us as Election Results Roll In

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A voter at the Johnson County Arts and Heritage Center in Overland Park, Kan. on Tuesday.

A voter at the Johnson County Arts and Heritage Center in Overland Park, Kan. on Tuesday.

Photo: Katie Currid for The Wall Street Journal

Markets often get politics wrong, but it is rare to see them price in all three of the plausible results of a presidential election—Republican, Democratic and long-drawn-out legal battle—in one night. Last night delivered exactly that as the voters once again mocked the pollsters.

In one way markets did what they should: As the probabilities shifted, prices responded in the direction one would expect. Efficient markets!

Yet, the scale of the moves suggests wild swings in the mood of futures traders from near-certainty of a win for Democrat Joe Biden to near-certainty of a second term for President Trump, before shifting to near-certainty of a mess. Market craziness!

Tuesday night highlighted the problem markets have been giving investors since Dutch East India company stock was the only game in town: They move in the right direction, but move much too far. In the jargon, markets have momentum, and it befuddles investors. In times where information is scarce, momentum takes over—a problem visible not just last night but in the markets for much of this year.

A quick recap of last night: As the polls closed, there was a Biden surge, at least in the minds of traders. The 10-year Treasury yield jumped to 0.94%, the highest since the panic in March. S&P 500 futures jumped, and Nasdaq futures didn’t. The bet on a Democratic sweep of the White House and Congress was on more spending and more borrowing, pushing up Treasury yields and helping old-line industrial and consumer stocks, while creating an alternative to technology stocks for those seeking growth.

As it became clear that Florida had stuck with Mr. Trump and the Democratic “blue wave” was at most a blue ripple, traders reversed course. Treasury yields fell sharply, while Nasdaq futures soared 4.8%. There would be no fiscal splurge, so no help for traditional economically sensitive stocks, while tech remained the only growth option, with the benefit of no hostile Congress.

Markets then swung once again, with Treasury yields falling to 0.77% and stock futures giving up all their gains as it appeared likely that we will have a long wait for Michigan and Pennsylvania’s counts before we know who will control the White House. The risk of legal disputes justified a shift to a risk-off bet. The greater likelihood that Republicans will hold the Senate also meant monetary stimulus—low rates for longer and the Federal Reserve buying Treasurys—would have to stand in as fiscal stimulus prospects receded.

As I type, the swings are continuing, but the lesson is that markets can both get the direction right and overshoot. They are sort of efficient, but also sort of crazy.

Economist John Maynard Keynes set out the problem in a section of his “General Theory of Employment, Interest and Money” that every investor should read. Investors aren’t trying to spot the best companies, but to figure out which ones other people think will be best, or that other people think other people think will be best.

President Trump and former Vice President Joe Biden addressed supporters early Wednesday morning as votes were still being tallied. Biden said he was optimistic, while President Trump raised the possibility of election fraud without citing any evidence. Photos: Carlos Barria/Reuters; Stefani Reynolds/Bloomberg News

“We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be,” he wrote.

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And thus we get into momentum, even before millions of new day traders turned up on Robinhood with little information to go on aside from the price.

It isn’t so much that the market is getting the direction wrong. A Democratic sweep would justify higher Treasury yields, while a Republican Senate justifies lower yields. Equally, coronavirus lockdowns warranted higher prices for tech stocks. The question is just how much higher yields should be, how much higher tech stocks should go. In the absence of information, momentum can take prices far from fundamentals, as we saw with tech stocks this summer. Investors watching each other will be carried along with the tide—and sometimes carried out.

Write to James Mackintosh at James.Mackintosh@wsj.com