A look at contested elections and what they mean for markets

Published Sat, Oct 10 20207:38 AM EDT

(This story is only for CNBC Pro subscribers ) Many investors are worried that the presidential election won't be settled for some time after Election Day and are trying to position themselves ahead of any political turbulence. Deutsche Bank analysts studied the few prior elections when the results were contested to help its clients prepare for such a scenario. The investment bank found that these rare cases — the elections in 2000, 1876 and 1824 — were typically accompanied by bouts of volatility and a flight toward safer assets like U.S. debt. Former Vice President Joe Biden is widening his polling lead over President Donald Trump , but the concern about a drawn-out result remains with investors hedging for that scenario in the futures market, the bank points out. Contracts tied to Cboe's Volatility Index , Wall Street's top gauge of marketplace anxiety, show market participants think the VIX will pop north of 30 around Election Day. The fear gauge traded around 28 as of Wednesday afternoon. "The potential for a contested election was made stark at the first presidential debate," wrote Deutsche analysts Henry Allen and Jim Reid. "In financial markets, this nervousness over a contested election can already be seen, with VIX futures pricing in higher volatility into November, before subsiding again into 2021." The Democrat, who has led incumbent Trump in national polls for months, has extended his lead ever since the first presidential debate on Sept. 29. An average calculated by RealClearPolitics.com showed the spread between Biden and Trump grew from 6.8 percentage points before the debate to 9.4 as of Wednesday. But despite signs Biden may have an upper hand, Trump has warned without evidence that the election could be rife with fraud and, in the end, be settled in the courts. "With the potential for a contested outcome, we take a look at previous contested elections, examining what happened, the market reaction, and the implications for this year's election," the analysts wrote. Election of 2000: Bush v. Gore The first and perhaps most helpful election studied by Deutsche was the bitter contest in 2000 between George W. Bush and Al Gore. That race boiled down to which candidate won Florida's electoral votes. The tally in the state was so close that it forced recounts, legal action by the Bush campaign to stop the recounts and a fight before the Florida Supreme Court. Amid the uncertainty over the outcome, the S & P 500 fell 1.6% the day after the election before dropping another 0.7% and 2.4% on the subsequent Thursday and Friday. "In fact, November 2000 was the S & P 500's worst monthly performance of that year, with an 8% decline from start to finish," the Deutsche team wrote. "With US equities losing ground, investors moved into US Treasuries, as 10yr yields fell from 5.86% at the close on Election Day to 5.26% on December 13 when Gore conceded." "The main lesson for today from 2000 is that the court process can take far longer than expected, and that uncertainty leads to a significant impact on share markets," they added, "And that is before considering today's contentious issue with mail-in ballots." Election of 1876: Hayes v. Tilden Back in 1876, a candidate only needed to win 185 electoral college votes to win, but the initial voting showed Democrat Samuel Tilden with 184 votes and Republican Rutherford B. Hayes with 165. In doubt were 20 Electoral College votes, including those from Florida, Louisiana and South Carolina. The debate over these votes was so fierce that Congress was forced to create a 15-member Electoral Commission to settle the election, which would only come months after Election Day. As in the 2000 election, equity markets fell as the dispute raged, the analysts found. Still, the market implications from 1876 as tough to decipher since the election occurred right in the middle of what is today known as the "Long Depression" that lasted from 1873 until 1879. "As with 2000, a scenario like 1876 - where the election is disputed in multiple states - raises the prospect of a protracted legal battle over the result," Deutsche Bank wrote. "Any dispute today is likely to be solved quicker than in 1876, because inauguration day is now held on January 20, rather than March 4 as it was then, meaning that the effective deadline to resolve the problem falls earlier." Election of 1824: Quincy Adams v. Jackson U.S. elections have changed in many ways since 1824, the last time no candidate achieved a majority of votes in the Electoral College thanks to a 4-way split between the different contenders. According to the U.S. Constitution, if no candidate receives a majority of votes, the election is then decided by the House of Representatives. Once a presidential election reaches the House, each state delegation receives one vote. All representatives from New York, for example, have a single ballot between them. Though extremely rare in modern elections, the race between Trump and Biden could in theory result in a 269-269 tie, Deutsche researchers wrote. "It's not impossible, and FiveThirtyEight's model puts the chances at around 1 in 200," the analysts wrote. "In fact, there already seems to be awareness in Washington at such a scenario, since House Speaker Nancy Pelosi recently wrote of the importance of winning state delegations for Democrats, in case the election is decided in the House."

U.S. President Donald Trump and Democratic presidential nominee Joe Biden speaking during the first 2020 presidential campaign debate.

Brian Snyder | Reuters

(This story is only for CNBC Pro subscribers)

Many investors are worried that the presidential election won't be settled for some time after Election Day and are trying to position themselves ahead of any political turbulence.

Deutsche Bank analysts studied the few prior elections when the results were contested to help its clients prepare for such a scenario.

The investment bank found that these rare cases — the elections in 2000, 1876 and 1824 — were typically accompanied by bouts of volatility and a flight toward safer assets like U.S. debt.

Former Vice President Joe Biden is widening his polling lead over President Donald Trump, but the concern about a drawn-out result remains with investors hedging for that scenario in the futures market, the bank points out.