If the stock market doesn’t like uncertainty, then why has it been going up since Election Day? After all, investors don’t know how President-Elect Donald Trump’s policies will actually work out. On the other hand, if U.S. Vice President Kamala Harris had won the election, investors could have expected less uncertainty and more stability.
That’s not how the stock market sees it. Today, November 8, 2018, the Dow Jones Industrial Average DJIA 0.08% is up 4.9%. At the same time, the Russell 2000 index of small and midcap stocks, which are more affected by changes in the economy, has gained 10.1%, which is more than double the return of the Dow.
I talked to three finance professors—Scott Baker of Northwestern University, Nicholas Bloom, and Steven Davis of Stanford University—who have done a lot of research on the link between the stock market and uncertainty about economic policies. They helped me understand the market’s strong reaction to the election. From their point of view, the rise in the stock market since Election Day is not as crazy as it might seem.
The reason for this is that uncertainty about economic strategy tends to go down after an election for president. So less uncertainty and higher stock prices are not strange at all; they are what you’d expect.
That makes sense. Compare where we are now to some of the scenarios that many people thought would happen before the election on November 5. A lot of people thought it would take days or even weeks to count all the votes and pick a winner. A lot of people were afraid that there would be a lot of bloodshed. So the fact that the election was held in a planned way and the results were known by the next morning greatly reduces doubt.
Davis said in an email that last week’s market rally fits with what has happened in the past. Professors made an Economic Policy Uncertainty measure (EPU) that was, on average, 13.5% higher in October of presidential election years in the U.S. than in any other month of the four-year presidential term. This has been the case since 1985.
Davis said, “I don’t see a big puzzle here,” unless you think that a Trump presidency would make things so much less certain that it would “overwhelm the usual uncertainty-reducing effects of elections.”
Bloom also said, “This election has taken away a lot of uncertainty because we now know for sure who will be in charge next.” Without a doubt, he said, “Uncertainty could rise again… in January when new policies are put in place, especially if they are extreme or controversial.” But right now, the markets are doing great and there doesn’t seem to be much doubt.
The market is getting a boost from less doubt, and normal seasonal factors are making it even better. Due to the stock market’s good performance so far this year, holiday pay bonuses on Wall Street are expected to be bigger than usual this year. And managers of mutual funds who want to do well at the end of the year are adding fuel to the fire.
In January, these seasonal factors no longer matter, which may happen at the same time that Trump takes office and economic policy volatility rises. That’s when the stock market might start to have trouble, as it usually does in the weeks after Jan. 20. The stock market might be stronger than most people think until then.
