Analysis-Risks from potentially contested US election appear on market's radar

By Lewis Krauskopf and Saqib Iqbal Ahmed

NEW YORK (Reuters) - A tight U.S. presidential race is leading some investors to brace for an unclear or contested election result that could trip up this year’s booming stock market rally.

With less than a month before the election, polls and prediction markets show Democrat Kamala Harris and Republican Donald Trump in a virtual dead heat. Harris led Trump by a marginal 46% to 43% in a Reuters/Ipsos poll released on Tuesday, a tighter race than the same poll showed a couple weeks earlier.

Given Trump's efforts to overturn his loss to President Joe Biden in 2020, investors expect any close outcome might also be contested this year. The balance of power in Congress is also at stake, with a number of potentially close contests that could ratchet up uncertainty.

"This is going to be a very close election. It just stands to reason that the likelihood of some type of dispute occurring is higher than it is on average," said Walter Todd, chief investment officer at Greenwood Capital. He expects stocks to sell off if the result is in doubt for more than a few days.

"Markets do not like uncertainty, and they certainly would not like the fact that we don't know who the president of the United States is a day or two after the election,” Todd said.

For now, political uncertainty appears to be doing little to dampen enthusiasm for stocks, as strong U.S. economic growth has helped the S&P 500 power to fresh highs. The benchmark index is up 21% so far this year and on track for a second straight year of double-digit gains.

That’s not to say the election isn’t on investors' radar. The Cboe Volatility Index, which measures options demand for protection against stock swings within a 30-day period, has risen about 6 points from its September lows and now stands at 20.9 - a level typically associated with moderate to higher expectation for market turbulence. Some of the index's rise is attributable to the looming election, investors say.

Options markets also reflect increased concerns about tail risk - a market shock due to an unlikely but highly impactful event. The Nations TailDex Index, a measure of such risk, recently hit its highest level in a month.

Michael Purves, CEO of Tallbacken Capital Advisors, believes investors are too focused on the days before and immediately after the vote, when a contested election could roil markets in the weeks after Nov 5.

"It's really not so much about the outcome as it is about the potential risk of the morning after, of the election not being considered valid by a large part of the population," he said. "That to me is a real risk ... a litigated outcome, where the stock market probably sells off."