Tomorrow's Election and the S&P

The basic fact about any financial market is that at the current market price as many people expect the market to go up as expect it to go down.

To put this another way, the price adjusts to the point where the pessimists are willing to trade with the optimists and vice versa. The market generally seeks a price that will facilitate the most trading between these two groups.

This essentially is what economists mean when they say that the current market price already reflects the best assesments of publicly available information.

The flip side of this coin is that news affects markets only when it is a surprise.

With this in mind let's consider the likely consequences for the S&P 500 of the outcome of tomorrow's elections in the USA.

The consensus expectation for tomorrow's electoral outcome is that the Republicans will loose control of the House of Representatives but keep control of the Senate. Trade Sports futures contracts on these events put the odds of a Republican loss of the House at 4 - 1 and the odds that the Republicans keep the Senate at 3 - 1. This is pretty much in line with the odds quoted in other prediction markets I have checked.

So if this is indeed what happens I don't expect much reaction from the markets in generally and in particular not much reaction from the S&P's because I think this outcome has already been priced into all the markets.

But what about a result different from the consensus? If the Republicans loose both the House and the Senate I think one would reasonably expect the S&P's to break on the news. The key thing in this event is to see just how much selling comes into the market. I think there won't be too much because the trend is upward and news events like this rarely change the trend's direction. This would be an opportunity to apply the "dog that didn't bark" principle.

Probably the least anticipated outcome would be a Republican retention of the House and the Senate. Should this happen I would expect the current rally to accelerate and probably to carry past my 1410-20 short term target zone. Even in this case one should keep in mind the "dog that didn't bark" principle when evaluating the market's response.

My own view on what will happen? This election has aroused my contrarian instincts. I think the Republicans will do a lot better than the consensus predicts and that the market surprises are more likely to be on the upside than on the downside.