US markets on edge for more election surprises

Bombshells notwithstanding, US stock markets still see a victory by Republican presidential candidate Donald Trump as the less likely outcome of the November 8 vote, analysts say.

But if he does defeat Hillary Clinton, the Democratic nominee, the reaction could be dramatic. What is less clear is whether that initial post-vote market reaction will last. 

MIT economics professor Simon Johnson, former chief economist of the International Monetary Fund, says the reaction could be brutal, given the fragile state of the US and global economic recoveries.

"A big adverse surprise -- like the election of Donald Trump in the US -- would cause the stock market to crash and plunge the world into recession," Johnson said in a column published Monday.

"Trump promises to boost US growth immediately to 4-5 percent, but this is pure fantasy. It is far more likely that his anti-trade policies would cause a sharp slowdown, much like the British are experiencing."

Johnson warned that Trump "would not need congressional approval to slam the brakes on the US economy," and that would push Europe back into recession as well.

While he noted that investors "regard a Trump presidency as a relatively low-probability event," if they are wrong, he said, "we should expect... a likely crash in the broader market."

- 'October surprises' shake markets -

This presidential campaign is far different in tone than any in recent memory, so political analysts who dismissed the "October surprise" effect on US elections as mostly myth, may be eating their words.

Twice in the past month surprise revelations have rocked the campaigns of the two candidates, both times sharply moving Wall Street -- though in opposite ways.

The Dow gained 0.5 percent the day following the release of the recording of Trump describing in vulgar language his behavior towards women, which many saw as an admission of sexual assault. Yet stocks fell back the very next day.

And the market fell sharply by 1.0 percentage point last Friday on news the FBI is investigating a new trove of emails possibly tied to Clinton's use of a private email server while secretary of state.

But shares rebounded some ground by the close, and were flat Monday.

- Dangerous 'black swan' risks -

With just a week left before the key vote, some analysts warn of unforeseeable "black swan" events.

"We have warned throughout the campaign that black swan risks, including scandals and information warfare, are extraordinarily high, and hence have been less bullish for a Clinton victory than consensus," Citi Research analysts Tina Fordham and Tiia Lehto wrote in a report. 

"The extent to which the 11th hour development will influence voter behavior is likely to remain uncertain right up until Election Day." 

While they still see a 75 percent probability of a Clinton victory, the latest development certainly will "further dent voter confidence," the analysts added.

But, as was the case with the two October surprises, there is ample research that stock market reactions following elections do not last long and do not favor either party.

A 2004 Federal Reserve research paper debunked the notion of a stock premium under Democratic administrations, saying: "Ultimately, our results are consistent with the notion that neither risk nor return varies substantially across the presidential cycle."

And BlackRock investment strategist Russ Koesterich wrote earlier this year that who wins the elections does not really matter to stocks over time -- mirroring his analysis of the 2012 election as well.

"Historically, whether a Republican or Democrat occupies the White House has had no statistically significant impact on US equity markets," he said.

However, he and other researchers see trends indicating stocks perform better in the third year of an administration and worse in the first year.