Preparing for Short-Term Election Volatility

What’s better for investors, Republican Presidents or Democrat Presidents? It’s a trick question. First, because in general, over the long run, it doesn’t matter. While some data correlates Democratic administrations with stronger markets since the end of World War II, there is no evidence of a cause and effect relationship. And this nifty interactive exhibit from our friends at Dimensional Funds, with data for nearly 100 years of US presidential terms, shows a consistent upward march for US equities regardless of the administration in place.

But that’s not what this blog is about. Rather, this article concerns what may be a bout of unprecedented market volatility between election day and the time when the winner is determined and installed into office; in the event neither party concedes.

I do my best to keep politics out of my investment writing because it can really cloud your judgment and contribute to bad investment behavior. But it’s a bit difficult at the moment. As an investor it would be best to steel yourself for the possibility of an acute dose of volatility.

Uncertainty May Abound

As if this past spring’s stock market volatility brought on by the coronavirus wasn’t enough. Now we’re on the cusp of what may be one of the most contentious presidential elections in our nation’s history. While virtually no one forecast how quickly the global pandemic would envelop the world; if you look carefully enough, you can see the outlines of a possible calamity in the making with the upcoming election.

The volatility is already ramping up, as investors are bidding up prices of the types of securities that perform well in periods of extreme volatility.

“It is being priced as one of the most volatile expected events of all time,” said one trader.

During the 2000 Florida recount battle, which lasted about a month, the S&P 500 lost nearly 10%, yields on Treasury notes fell 52 basis points and gold gained over 12% before Vice President Gore conceded on December 13th, “for the sake of our unity as a people and the strength of our democracy.” Given the posturing over the “legitimacy” of mail in ballots, it is possible that neither party will have conceded by that date in 2020; let alone, what may happen if one party is claiming victory before all the votes have been tabulated.

Some Wall Street analysts expect trading on election night to reach up to eight times its normal level.

Election Night, Election Week or Election Month(s)?

As an electorate, we are used to elections being called around midnight on Election Day. Or early the next morning. That’s not likely to happen in 2020. Analysts are expecting an unusually high turnout; with an extraordinary number of early votes, absentee and mail-in ballots. Perhaps fewer than half of this year’s ballots will be cast in person on Election Day, largely on account of the coronavirus. And millions will be voting by mail for the first time. Some states start processing mail in ballots before Election Day. Others are required by law to wait until Election Day.

There can be many reasons why a ballot may not be counted. Many states have laws invalidating ballots which are mailed before Election Day but arrive after Election Day. Absentee ballots have strict postmark, signature and envelope requirements. Hundreds of thousands of ballots were invalidated nationwide during the primaries.

Even in the best case, obtaining final canvassing tallies and certification in key states may very well brush up against the six- and eight-week deadlines in federal law for processing the results.

President Trump has signaled on numerous occasions, including during the first Presidential debate, that he is preparing to declare victory on election night – before all the votes are counted – and to question the legitimacy of any outcome that does not favor him, on the basis that mail-in and late counted ballots are fraudulent. And that he is prepared to extend the election through litigation or otherwise up to Inauguration Day or beyond. Investors should take him at his word.

The quaint 2000 Florida Brooks Brothers Brigade may turn into something more violent and widespread, particularly if a mass of poll watchers is deployed nationwide and voting or canvassing is disrupted.

Bush v. Gore on Steroids

Much to our collective dismay, there are gaps and ambiguities in the Constitutional infrastructure for electing our president. These vagaries are ripe for exploitation by an aggrieved candidate. Some of these questions were tangentially addressed in the Supreme Court’s 2000 Bush v. Gore decision. But this time we may enter a Constitutional black hole.

There are a multitude of sources from which to understand the byzantine journey your single vote takes before a President is sworn in, every four years, on January 20. This eerily prescient and scholarly law review article by Ohio State University Constitutional Law Professor, Edward B. Foley, published in 2019 (even before the pandemic will have caused an unprecedented number of mail-in ballots to be utilized) painstakingly demonstrates the fault lines in our Constitution that could emerge in a close and bitterly contested election.

There are several scenarios of how such a controversy might play out in the 2020 election and the not-unlikely scenario in which the election delivers a narrow or disputed result in favor of one candidate and the other refuses to concede. Another scenario might be if a foreign adversary were to hack and shut down the balloting in a major city on Election Day. Canvassers will undoubtedly have to count millions of absentee, mail-in and provisional ballots in the days following November 3rd.  And, for example, if swing-state Pennsylvania (or multiple states) were to submit competing slates of electors. It’s not pretty.

The uncertainty, similar to – or even worse than – the Bush v Gore imbroglio in 2000, could go on for months and cause a great deal of social and financial disruption on top of what we are experiencing with COVID-19.

Regardless of whether you are a Trump or Biden supporter, the possibility of upheaval during the weeks following the election and the effect it may have on the markets makes it worth understanding the intricacies of our electoral process.

Constitutional and Statutory Maze

The prescribed election timeline is generally laid out in two Constitutional provisions and a federal statute. Article II, Section 1, Clause 3  was the original provision but was superseded by the Twelfth Amendment, after the disputed election of 1800.

When you cast your ballot on Election Day, November 3, 2020, you are not actually voting for a candidate, but for a slate of electors pledged to vote for that candidate when the electoral college meets in each state on December 14. The certified results are then sent by the Governor of each state to the National Archives. A certification by December 8 is given special deference by Congress when counting the electoral votes on January 6, 2021. Following the meeting and vote of the electors on December 14, electors send a certificate of their votes to both the National Archives and the President of the Senate, Vice President Pence.

Under the 12th Amendment, a joint session of the new Congress (see the 20th Amendment) convenes on January 6, 2021 to count the votes and declare as the winner the candidate receiving a majority of the electoral votes. The Vice President, as President of the Senate, presides over the proceedings. A candidate needs 270 electoral votes to win, assuming all of the electoral votes are counted. (It is an open question how many are needed if not all the states’ electoral votes are included in the final count, if, for some reason, they are rejected by the joint session of Congress.)

Potential Duplicity

A review of the provisions that apply reveals a number of fissures in our system for electing a President.

If each state and the District of Columbia sends only one certificate to Congress, the election will be resolved on the basis of those certificates. However, under circumstances of a highly disputed contest, it is possible that one or more states send what purport to be two conflicting slates of electors to Congress; sending us into waters not charted in nearly 150 years.

Once in our history (the highly disputed election of 1876 between Democrat, Samuel Tilden and Republican, Rutherford B. Hayes) the Congress received two sets of “certified” results from three states; casting the election into chaos. (In 1960, Hawaii sent two slates to Congress, but it didn’t matter in the final result.) Ultimately, in a deal allowing Hayes to prevail, Republicans, in exchange, agreed to apply the brakes to post civil war reconstruction; sowing the seeds for a century of Jim Crow. Volumes have been written about this sordid affair in American history.

One of the consequences of the 1876 election was passage of the Electoral Count Act of 1887, designed to avert a future such constitutional crises. This legislation followed and consolidated a spate of both passed and failed legislation – and Congressional rules – beginning in 1792;  as well as on several occasions in the intervening decades, in which Congress had to untangle contested electoral college votes submitted by one state or another.

The most important provision of that statute, which is still on the books, is Section 15, which describes the procedure in the event the Congress receives dueling slates of electors. That provision has alarmingly been described by political scientists as “almost unintelligible.”

In his article, Professor Foley describes it as ”a monstrosity, amounting to a virtually impenetrable maze of 807 words.” Read it and weep.

It has been reported that supporters of President Trump are already planning to encourage legislatures in states in which he loses the popular vote to send competing slates of electors to Congress.  Although there is a strong argument that a state legislature may not constitutionally appoint a slate of electors after a popular election has been held for that purpose, there may be no mechanism for that to be adjudicated, other than in the halls of Congress beginning on January 6, 2021

Whither the Vice President?

As mentioned, under the 12th Amendment, the Vice President, as President of the Senate, presides over the joint session of Congress in counting the votes. While there may be a hint of ambiguity on the point; it is assumed – and history strongly supports the notion – that his role is largely ministerial and has no substantive duties, which are left entirely to Congress. Except, plausibly, for the breaking of a tie vote in the Senate under Article 1, Section 3, Clause 4. But, as unseemly as that might appear, it wouldn’t be impossible for Vice President Pence to attempt to assert control over the outcome.

The various permutations and scenarios of how this plays out in Congress, the state and federal courts, including the Supreme Court, are too numerous to comprehend and to detail here. Professor Foley details several of them in his article, which I commend to your reading. In one mind blowing scenario, both Donald Trump and Nancy Pelosi (as Speaker of the House, under the 20th Amendment and the presidential succession statute) stake claim to being inaugurated on January 20th and become commander-in chief.

In that event, it may be as hard to find popcorn (and Valium) as it was to find toilet paper in March.

It Will (Probably) be Resolved

Even the proverbial blind man might see this coming. In June of this year, the bipartisan Transition Integrity Project, war-gamed out some possible post-election night scenarios and issued a 22 page report, concluding “with a high degree of likelihood that November’s elections will be marked by a chaotic legal and political landscape.”

It may not be pretty. And perhaps not to your liking. But the election will likely be resolved under our imperfect Constitution. The worst-case scenario, procedurally, is that the House of Representatives (voting by state delegation) decides the Presidential election under the third clause of the 12th Amendment; which has happened twice in our history, in 1800 and 1824. Unless it’s a Tie! Then we are in no man’s land. (Also under the 12th Amendment, the Senate would elect the Vice president.)

Of course, there is a minute chance that the election is not resolved constitutionally. And the military becomes involved, one way or the other. In either event, we may have long lasting damage to our democracy.

After which, whatever chaos and volatility has been occurring caused by the electoral uncertainty will come to end. There will of course be the political aftermath. But the course of the economy and the markets will largely then be determined by the status of coronavirus pandemic and our policy responses to it.

Don’t Panic

By all means, do everything you can to be sure your overall asset allocation strategy can withstand an event like this, whether it happens, or not. No asset allocation strategy is likely survive the absolute end to our great democratic experiment. As Hobbes described, life in the state of nature is solitary, poor, nastybrutish, and short!

It is only natural and human to become anxious during times like these and even to panic. But, as this Coronavirus market meltdown volatility study by Vanguard shows, investors overall do a terrible job of timing these sorts of things.

A wise person once said, no emergency was ever improved by panicking.

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