Trump vs. Harris could make politics matter to stocks again. Here's what investors will be watching.

By Joseph Adinolfi

President Joe Biden's decision not to seek a second term has upended the calculus for this year's election. So far, it doesn't appear to be having much of an effect on markets.

But that could change once fall arrives and, with it, the final stretch of the presidential campaign. Wall Street will be keeping a close eye on the polls, with a focus on key swing states like Pennsylvania, Ohio, Michigan and Florida.

If no front-runner has emerged by that point, stocks could feel the sting of uncertainty as Election Day creeps closer.

Until then, earnings season, economic data and the prospect of multiple Federal Reserve interest-rate cuts remained front and center for investors on Monday, and will likely continue to set the agenda for stocks over the rest of the summer.

See: Stock futures inch higher, but Biden's withdrawal adds to increasingly uncertain outlook for markets

"If polls stay within the margin of error, we would expect more volatility," said Mark Malek, chief investment officer at Siebert Financial, during an interview with MarketWatch on Monday. "Strap in, pull tight on the lap belt, because it is going to be a bumpy ride."

Previously, polls had predicted a tight race between President Biden and former President Donald Trump - though Trump had seen his advantage widen after Biden's disastrous debate performance last month and the assassination attempt on Trump's life on July 13.

Vice President Kamala Harris emerging as the new front-runner for the Democratic nomination has effectively delivered a "reset," according to strategists at UBS Group and J.P. Morgan. And it could take some time for investors to decipher the nuances of what her candidacy might mean for their portfolios.

Investors will now need to wait and see how the new Democratic ticket takes shape between now and the Democratic National Convention in August. Even if Harris faces an easy path to the nomination - as many expect following an outpouring of endorsements from key Democratic figures, including Biden and congressional leaders like Nancy Pelosi - crucial questions like who her running mate might be remain unanswered.

It also unclear exactly what the policy platform espoused by the new Democratic ticket might be, and whether it differs from what Biden had been advocating for on the campaign trail and in the White House.

"The first thing that markets need to do is reacclimate and understand where Vice President Harris's policies differ from what Joe Biden has campaigned on up until this point," said Michael Reinking, senior market strategist at the New York Stock Exchange, during an interview with MarketWatch on Monday.

Another potential wrinkle from polling data that could impact markets is the likelihood that the U.S. could see a "red wave" at the ballot box in November, in which Trump retakes the White House and Republicans gain control of both houses of Congress.

The expectation is that the odds of such an outcome have diminished now that Biden has stepped aside, according to Reinking. But it will be a few days, at least, before investors can parse through the first batch of new polls on the presidential election and key congressional races. Some view the prospect of a red wave - which would allow a future Trump administration to push through nearly all of its policies with little resistance - as potentially negative for stocks.

Typically, politics ranks low on the list of things that matter to investors. So why would it matter now when there are already so many other crosscurrents tugging at markets?

The answer is rooted in companies' approach to corporate strategy. Many could find it difficult to make major decisions in the absence of a clear front-runner, according to Victor Cossel, senior macro analyst at Seaport Research Partners.

"Until you know who might win the White House, and who might win control of the legislative branch, you really don't know what you should be spending your money on," Cossel said during an interview with MarketWatch.

Beyond Election Day, parsing how investors might respond to a future Trump or Harris administration becomes even more murky.

Policies espoused by Trump could help revive inflationary pressures, while concerns about the budget deficit could push Treasury yields higher, Malek said. Both of these outcomes have negatively impacted stocks in the past.

But investors will need to weigh this eventuality with the potential boost that corporate tax cuts and deregulation might have on corporate profits, and whether a red wave would be necessary to put those types of policies into practice.

That doesn't mean investors aren't already trying. The so-called Trump trade is believed to have boosted oil-and-gas stocks, private prison companies, financial-services firms and cryptocurrencies, while weighing on shares of retailers that rely on cheap imports, as well as clean-energy stocks. Some healthcare names are also said to have benefited from the Trump trade.

However, it is difficult to ascertain exactly how much these moves have been driven by politics, and how much they're the result of a rotation away from Big Tech stocks into other corners of the market.

Another facet of the Trump trade is that the Treasury yield curve has steepened, with long-term yields rising faster than their short-term peers.

There was scant evidence on Monday that the Trump trade was unwinding, as stocks embarked on a broad-based rebound following last week's volatility, while the shape of the Treasury yield curve was little changed.

However, shares of some companies closely associated with the trade fell - including those of private prison company Geo Group Inc. (GEO)

"A lot of what is driving markets right now is just kind of the stretched positioning that we have had," Reinking said.

The S&P 500 SPX rose 59.41 points, or 1.1%, to 5,564.41 on Monday, while the Nasdaq Composite COMP climbed 280.63 points, or 1.6%, to 18,007.57. The Dow Jones Industrial Average DJIA gained 127.91 points, or 0.3%, at 40,415.44.

-Joseph Adinolfi

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07-23-24 0859ET

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