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Why election could be the next headache for stocks

Traders work on the floor of the New York Stock Exchange.
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Traders work on the floor of the New York Stock Exchange.

The presidential election is adding uncertainty to an already cranky stock market, and it could begin to impact prices even more as the primary season gets underway.

As Iowa held its caucuses Monday, stock prices fell on the same worries that have been driving them lower for weeks — weakness in China, disappointing U.S. data and falling oil prices. But analysts say there is also the unquantifiable effect of uncertainty surrounding the presidential election that may also be weighing on the minds of investors.

"Anyone who has a difficult time picturing any one of the candidates as president may be having a hard time jumping into the stock market with both feet," said Jack Ablin, CIO of BMO Private Bank. "If you're uncertain to begin with and you're putting together a list of uncertainties, it's certainly one of them. It's a wild card, and one that doesn't really have an outcome that seems that visible right now."

Iowans were the first to vote in a race where so far former Secretary of State Hillary Clinton and billionaire Donald Trump are the front-runners. Trump is among a dozen GOP candidates and is in a close contest in Iowa with Sen. Ted Cruz. Clinton's lead rival, Sen. Bernie Sanders, has been gaining momentum among Iowa's Democrats.

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Iowa is important in that it could shape the field of candidates going forward, as could next week's New Hampshire primary. While Trump has been the lead GOP candidate, strategists have said it's not clear he can deliver votes.

"It's about momentum and expectations," said Daniel Clifton, head of policy research at Strategas. "If Trump actually can't deliver the voters then it looks like more smoke than real and his numbers go down everywhere else."

The range of ideologies among candidates spans the spectrum, with Trump and Cruz appealing to right wing of the GOP and Sanders, appealing to the Democratic left.

Clifton said some investors are concerned about Trump because he is viewed as a protectionist on trade and the market could breathe a sigh of relief if he falls out of first place.

Stocks ended mixed Monday, with the S&P 500 and Dow down slightly and the Nasdaq up modestly.

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"I think the macro sentiment that's building right now is you have a populist revolt that's happening, and the implication of that is you're going to have less trade, possibly higher taxes," said Clifton.

But Trump is also viewed positively by some because there is a perceived lack of American leadership on the world stage, and some investors believe that's one area he could improve, Clifton said.

"There's just an uncertainty to him," said Clifton. "We have no idea what he's going to do. He's brand new. He's totally unpredictable."

Some analysts say the fact that a more traditional candidate is not taking the lead on the Republican side has concerned investors.

"I don't think the markets are happy with any of the candidates," said Sam Stovall, chief U.S. equity strategist at Standard & Poor's Capital IQ. "Both Hillary and Bernie fall over themselves to say what they're going to do to Wall Street when they get elected, and other than Donald Trump, I'm not sure that any of the Republicans understand the importance of Wall Street to Main Street."

Stovall said historically, the eighth year of a presidency has not gone well for stock market returns. "Since World War II, the S&P has fallen an average 3.3 percent in the years when the incumbent president is not allowed to run or has chosen not to run," he said, adding that the market has been down half of the time in the eighth year.

Analysts say while the overall stock market may not yet be reacting to the candidates, it's clear that some sectors are. The bond market may also be seeing more of a bid as a result of the election process. "It certainly contributed to the generally uncertain outlook for this year in both the real economy as well as financial markets," said Ian Lyngen, senior Treasury strategist at CRT Capital.

"Certain sectors of the market have been influenced by the candidates, like biotech. I would think the market is discounting a Hillary win. That is what it's been doing for the past six or 12 months," said Jeffrey Mortimer, director of investment strategy at BNY Mellon Wealth Management.

If Clinton starts to look as if she will not be the winner, analysts expect the market to react, as it adjusts to the policies of the new front-runner.

"She's got a greater than 50 percent probability to be the next president. I would say that's the consensus on Wall Street and our view is that probability is going to whittle down over the next few months," said Cilfton.

Among the topics investors are focused are minimum wage, tax reform, health-care reform, financial services reform, energy and climate change, and cybersecurity, according to Barclays strategists.

"We sense that investors are watching the proceedings closely but are not altering investment allocations in response. This could begin to change as the primary season commences," wrote the Barclays equity strategists, in a note Monday. Ablin and others say the impact on individual sectors should increase as the election gets closer and the field of candidates is pared down.

The iShares Nasdaq Biotech ETF has fallen 27 percent since Clinton first tweeted Sept. 21 about Turing Pharmaceuticals' steep price hike for Daraprim, a drug used to treat parasitic infections. She called the price increase "outrageous" and announced in the tweet that she had a plan to take on price gouging.

"I think both sides are adding to the pressure on the health-care sector. Hillary and Bernie, by saying they're going to cap drug prices, and basically all the Republicans saying they're going to undo Obamacare which is going to inject total uncertainty into the health-care sector," said Stovall.

Clifton said the fact that Trump, a Republican, also joined the chorus on drug prices last week, created even more uncertainty around the pharmaceutical sector when he said there should be Medicare negotiations for prescription drugs.

Democrats have also called for more regulation of the financial industry, while GOP candidates have proposed removing some of the new financial services legislation adopted since the financial crisis.

"Specifically, Bernie Sanders voted for a bill to recreate the Glass-Steagall Act that previously separated investment banking from retail banking. Hillary Clinton has proposed further strengthening the Dodd-Frank Act while at the same time introducing a high-frequency trading tax Conversely, Donald Trump, Marco Rubio and Jeb Bush have discussed repealing the Dodd-Frank Act while Ted Cruz and Ben Carson have criticized the creation of the CFPB (Consumer Financial Protection Bureau)," wrote the Barclays strategists.

They said further regulation would hurt the S&P 500 bank stocks, which have seen their return on equity fall to less than 10 percent, from the more than 15 percent before the financial crisis. On the other hand, GOP efforts to repeal Dodd-Frank would be viewed as favorable, but the analysts do not anticipate any near-term changes in financial services legislation.

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The candidates have also been divided on energy and climate change.

"Bernie Sanders has argued against fossil fuel subsidies, offshore oil drilling, pipeline projects and natural gas fracking while Ted Cruz, Donald Trump, and Marco Rubio have downplayed global warming," the Barclays analysts noted. On cybersecurity, they expect it to get more attention from the candidates, and that could benefit the information security stocks.

Stovall said while investors may not be reacting that much to the election, they may be sensitive to what's been going on in Washington.

"I think investors are more concerned about nothing being done from a fiscal perspective or a leadership perspective out of Washington for this entire calendar year, and investors realize if nothing gets done next year, it won't get done during a midterm election the following year either," Stovall said.

He said the split Congress made for a leadership vacuum and now the next president and Congress have one year to act before the congressional midterm elections.