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What moves the markets: The role of the US Election and its effect on the stock and crypto market

MachinaTrader
Coinmonks
9 min readNov 3, 2020

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It is well known that financial markets follow patterns such as the economic growth of a country in the long-term perspective, but also react sensitively to short-term effects such as news, political situations, economic activity, or external effects, as prices of assets reflect investors’ expectations about the future payoffs. This article examines i) the overall effect of such events with a focus on the coronavirus, ii) the potential correlation between the stock market and the crypto market, iii) how the upcoming US elections will act as a catalyst for the stock market, and what the pre- and post-election effects are.

During the recent global Covid-19 pandemic, we have seen that, apart from the impact on the health sector and households, most industries have been affected by the restrictions imposed by the coronavirus outbreak, meaning that tourism, restaurants, manufacturing, retailers, etc. have been reduced in their ability to function and the global “pause” in anticipation has led to a global slowdown in economic growth.

Figure 1 — Change in value of selected indices during coronavirus worldwide, Source: Self-interpreted from Statista

Figure 1 indicates that global financial markets made moderate progress at the beginning of the year with an average increase of 2–3%, while the outbreak of the coronavirus showed a clear downward trend in value. Between January 1 and March 31, 2020, the US and EU stock markets fell by 30%, i.e. the expected dividend growth decreased by 28% for the S&P500 and 25% for the Euro Stoxx 50, measured by the stock market value, which is the discounted value of all future dividend payments, see Figure2:

Figure 2 — Cumulative return to the S&P 500 and EuroStoxx 50 Source: (1.Gormsen, N.J. and Koijen, S.J.)

At the same time, there were movements in the more decentralized and non-governmental crypto market, which showed that market capitalization and trading volumes were positive in the initial phase, but during the continuous coronavirus spread, the impact was negative with higher price volatility in the leading currency Bitcoin, which was followed by the others.

Figure 3 — Market cap relative to corona cases, Source: (2 Jabotinsky, Hadar Yoana and Sarel).

Figure 2 shows the change in the market cap of Bitcoin, Ether, and Ripple in relation to the progress of corona cases worldwide. As an alternative to dividends on the stock exchange, the value was measured by market capitalization, which indicates the value of the token and the trading value from January 1 to March 21, 2020. The estimation indicates a U-inverse ratio with a moderate increase in market capitalization at the beginning, followed by a rapid decline in mid-February when the coronavirus and related deaths continued to increase (2 Jabotinsky, Hadar Yoana and Sarel). In the short term, investors are willing to switch from traditional to alternative investments such as crypto in a crisis due to distrust of the government and banks, but in the long term, there is no consistency, which can be explained by various behavioral aspects, such as the impatience of investors who invested during the last bull run in 2016 or informed investors who follow the strategy of pumping the crypto market with the expectation of small investors who follow to deposit the assets to obtain short-term returns or the confidence of investors increases as governments take action during the crisis, thus increasing the likelihood of a recovery in the financial markets.

ii) The stock market and the crypto market were unable to resist external effects such as the coronavirus, which was only partly to be expected for the stock market, however, the extent of the coronavirus has spread globally and several industries and working approaches have been constantly changed (eliminated), while the crypto market also showed little resistance in the long term, as investors’ expectations were either pessimistic or in favor of other factors independent of the coronavirus that drove the big sell-off. The question is whether there is a correlation between the stock market and the crypto market, which is important to investigate apart from the coronavirus, but since Bitcoin started trading in 2013, there is only a limited history between the stock market and the crypto market as the last financial crisis occurred in 2007–08, which was also the birth of Bitcoin, as mistrust in financial institutions and the government has increased. The recent coronavirus can be seen as an interference that deviates from historical events, as the scale of the pandemic exceeded the financial crisis and the dotcom bubble in several ways.

Figure 4–180-day percentage price-change correlation between Bitcoin and traditional assets Source: BitMEX Research https://blog.bitmex.com/bitcoin-price-correlation-record-high-against-the-sp-500/

In Figure 3 we can observe the daily percentage price change in correlation between Bitcoin and the S&P 500, US Treasury bonds, JPY, Nasdaq, Gold, S&P 500 Volatility Index and Shanghai Composite Index throughout 2012–17. Note that there is less evidence of statistical significance as the R-squared was very low for all asset classes, so interpretation of the results remains speculative (Bitmex). The correlation of Bitcoin was almost in the range of -0.2 and +0.2, except for several outbreaks of Nasdaq, Gold and VIX. In the early years, Bitcoin showed a relatively negative correlation with other stocks, but throughout the expansion of the ecosystem, Bitcoin experienced a cyclical correlation between stocks, especially around 2016–2017. The most common correlation was observed between Bitcoin and gold during the Bitcoin price rally in 2013 and 2016, suggesting that they have similar factors driving the price, such as China’s economic slowdown, the choice of Brexit and the election of Donald Trump as President). It is noteworthy that Bitcoin has been outperforming the stock market for several periods, however, in recent years there has been an increasing correlation to traditional asset classes, resulting in less downside protection in case of a financial crisis.

iii) For the 2020 United States presidential elections, which are scheduled to take place on November 3, 2020, monetary effects on the stock market have been heavily discussed such as the “Presidential Election Cycle” effect (3. Stovall, Robert H.). Market movements can be identified throughout the pre-election period, but also by the post-election cyclicity of the presidency depending on the implemented policies of the current administration.

Pre-election indicators could be shown in the stock market chart of S&P 500 performance in the three months preceding election date, which can be used as a predictor of the US presidential election with proven accuracy since 1984 (4. Detrick, Ryan LPL financial chief market strategist). Taking the three months of the S&P 500 index into consideration, a positive return in this period signals an increasing probability of winning for the incumbent party, President Donald Trump, while a stock market loss in the three-month period could signal the opposition party, President Joe Biden, to take the lead.

Figure 5 — S&P 500 Performance during elections years Source : https://lpl-research.com/hoc/images/full/weakness-before-the-election.png

In addition, an increased likelihood of the presidential election was also based on the economic cycle where the occurrence of a recession in the last two years of the presidency raises the odds for the incumbent president, in this case President Donald Trump, while increasing the chances for the opposition ( 4. Detrick, Ryan LPL Financial Chief Market Strategist / Marketstretch)).

Empirical research on post-election indicators shows that the S&P 500 Index was defined by a four-year cycle from 1965 to 2003 from President, Lyndon Johnson to George W. Bush, which was characterized by falling stock prices in the first half of the presidency and sharply rising stock prices in the second half of the presidency, which peaked in the third year of the presidency, mainly in order to increase the probability of re-election after the fourth year, which was significant for the Republican administrations (not significant for Democrats), which on the one hand implied the engagement policy manipulations for re-election, and on the other hand, the implemented policies of the Democrats lead to rising stock prices during the entire presidency, which was also significant (not significant for Republicans) (5. Wong, Wing-Keung and Michael McAleer).

In conclusion, the growing crypto market has been shielded by all industries and analysts of various institutions, with a growing acceptance also at the institutional level, which can be considered a new “asset” class. We have found that the growing ecosystem and market capitalization are either positive for acceptance but rather negative in case of correlation with other traditional asset classes. It should be noted that the crypto market is still evolving, with new projects (i.e. DeFi and algorithmic trading platforms) expanding the crypto sphere and providing more upside potential while protecting against future turbulences on the financial market. As of today, the market conditions and anomalies from the coronavirus could lead to distorted results where presidential indicators could be inefficient, as markets have been equally affected on a global scale, with the recovery of the markets taking place at the same time as the presidential elections in the United States. Current movements in the U.S. market are either a signal of recovery or are more likely to result from the increasing uptrend in tech and utility stocks.

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Sources

Figure1: https://www.statista.com/statistics/1105021/coronavirus-outbreak-stock-market-change/

Figure2: Gormsen, Niels Joachim, and Ralph SJ Koijen. “Coronavirus: Impact on stock prices and growth expectations.” University of Chicago, Becker Friedman Institute for Economics Working Paper 2020–22 (2020).

Figure 3: Jabotinsky, Hadar Yoana and Sarel, Roee, How Crisis Affects Crypto: Coronavirus as a Test Case (March 22, 2020). Available at SSRN: https://ssrn.com/abstract=3557929

Figure 4: https://blog.bitmex.com/bitcoin-price-correlation-record-high-against-the-sp-500/

Figure 5: https://lpl-research.com/hoc/images/full/weakness-before-the-election.png

1. Gormsen, Niels Joachim, and Ralph SJ Koijen. “Coronavirus: Impact on stock prices and growth expectations.” University of Chicago, Becker Friedman Institute for Economics Working Paper 2020–22 (2020).

2. Jabotinsky, Hadar Yoana and Sarel, Roee, How Crisis Affects Crypto: Coronavirus as a Test Case (March 22, 2020). Available at SSRN: https://ssrn.com/abstract=3557929

3. Stovall, Robert H. “Forecasting stock market performance via the presidential cycle.” Financial Analysts Journal (1992): 5–8.

4. Dereck LPF: https://lplresearch.com/2020/01/17/a-closer-look-at-election-years/

4.1 https://lpl-research.com/hoc/elections-2020.html

5. Wong, Wing-Keung, and Michael McAleer. “Mapping the Presidential Election Cycle in US stock markets.” Mathematics and Computers in Simulation 79.11 (2009): 3267–3277.

Also, Read

Elections
Cryptocurrency
Stock Market
Crypto
Covid-19

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MachinaTrader
Coinmonks

Written by MachinaTrader

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