By: Paul Morrone
Politics and markets have a volatile relationship, but there is an inherent difference between volatility and correlation – and they are frequently mistaken. Volatility describes the magnitude of the various ups and downs something experiences while correlation measures how closely two things move together. Two factors that are closely correlated will move together in lockstep, however, if they exhibit a low degree of correlation, you really can’t predict the movement of one based upon the move of another. We’ve contested time and again that politics and markets are not correlated, but that doesn’t mean politics can’t incite volatility. Understanding (and separating) these two statistical measures is important to seeing the forest through the trees with respect to a longer-term investment strategy. The immediate reaction to the mid-term results was a perfect illustration of how volatility and correlation diverge.
If politics (or political outcomes) and markets were correlated, there would be a clear market trend when certain things occurred. For example, if markets always declined under democratic or republican leadership, this would be an example of markets and politics exhibiting correlation. The data shows just the opposite, markets have risen (almost equally as much on an annualized basis) under BOTH democratic and republican leadership. The same is true when one party controls the house. Or when one party controls all three branches, or when there is political gridlock (a divided house/senate/presidency). If you’re catching our drift, there is no pattern – and that is exactly the point. The only consistency is that markets have gone up over time, regardless of who is in charge.
The blue wave that swept the nation from South Carolina to Alaska proved that voter turnout and a reinvigorated democratic party would wreak havoc in some of the most red-blooded states and counties in the country. More importantly, they would learn from their mistakes in the last presidential election and 2022 midterms and would not be caught flat-footed in 2026. In a previously unthinkable outcome, senate, house and even Governor’s seats in Republican strongholds flipped blue for the first time in decades (or even centuries). How did this happen, you may ask? Those old enough to remember the 1992 race are quick to point out that the results should not come as much of a surprise because “It’s the economy, stupid.” And it is.
The average American is not happy with the political electorate – starting with the President – who American voters have held responsible for you guessed it, the economy. I have yet to meet anyone, regardless of their socioeconomic status, that enjoys $8 eggs, $6 per gallon at the pump or insurance premiums that have risen 30% over last year. The truth is, however, these numbers are mere annoyances for the 1%ers who have healthy and high-flying investment portfolios and represent a change of lifestyle for many average Americans who don’t even have $500 saved for an emergency. And the latter group showed up in spades at the voting booths on November 2.
In the immediate aftermath of the results (the day after) virtually all markets worldwide were green – and significantly so. There were pockets of weakness on day one which were hidden by the broad headline numbers, but those fears spread like cancer overnight and markets moved sharply downward only 48 hours after the polls closed. All things AI (including semiconductors, hardware, data, and infrastructure) were the target of a selloff that effectively erased the previous day’s gains and pushed the Nasdaq 100 into correction territory (defined as a decline of 10% from its 10/6/26 high). The Nasdaq measures a narrow subset of the investible ‘market’ and is laden with tech and communications heavy companies – typically characterized as growth companies. This means the Nasdaq is far more sensitive to forces impacting these specific sectors because it is not as comprehensive as a broader index such as the S&P 500 (down ~5-6% from its recent high) or Russell 1000 (down ~2-3% from its recent high). You’ve heard us preach diversification time and again, and this perfectly illustrates why.
Why did the Nasdaq and tech stocks suffer more than the rest of the market? Aside from the higher earnings multiples, inflation expectations and interest rate sensitivity of these sectors, it comes down to the statement that the Blue Wave is making across the country. Many of these tech stocks, and the ancillary industries that they support, may be subject to additional scrutiny as several democratic leaders have been anti-data centers. Should there be more regulation around these critical pieces of AI infrastructure, a curb on permitting and building or added delays due to political red-tape, the effects will be felt more broadly than just in semiconductors. From the company that preps the building site, to the contractors responsible for building the structure itself, the manufacturers of the computing hardware being installed, the owner of the structure or the land it is built upon, in addition to the owner/operator of the data center itself. That’s not to mention the companies financing these outfits, providing electrical power to them, insuring them or maintain them over time. All these companies – the entire supply chain – are being targeted in this AI driven selloff because of the election outcomes. Then there’s the potential impact this has on AI computing power and pricing that companies pay to access these resources going forward. Just like we are accustomed to paying our water or electric bill, AI computing tokens are quickly becoming a massive line-item on P&Ls from virtually all of the world’s largest companies. Without supply increasing enough to keep up with demand, this resource will remain an expensive one to access, and companies are only demanding more of it each year.
Now it’s way too soon to tell what, if any, landmark regulation is coming down the pike (keep a watchful eye on Texas). And we are certainly not implying that will even happen. Investors are just speculating, as investors do, on one of many, many potential outcomes over the next several years. One or two days’ trading activity does not provide anywhere near enough data to identify a long-term trend and, to be clear, we don’t believe that the tech trade is anywhere near over. The point here is that reactions are normal in a functioning market, uncomfortable, but normal.
Another theme that has been prevalent in our past writings was that geopolitical and domestic political risks generally create what we refer to as headline risk – which is very short-term in nature (back to that concept of correlation vs volatility that we opened with). Our thesis on this also remains the same. Headline risk is market reaction that takes place when something changes. Recent examples include the Liberation Day selloff after the initial tariff announcements, selloffs in early 2026 related to oil price increases or dramatic prices swings that we’ve seen after presidential or midterm election results. The common theme here is that markets react first and think second. The knee-jerk reaction is usually not the same as a decision focused on the long-term made in sound mind. In all cases, even after the latest selloffs, current market values exceed where we were immediately before these events. What we’ve also learned is that quick selloffs, and even sustained market declines, are followed by periods of rising prices (that often quickly lead to new highs) as investors settle and recalibrate their expectations for the future. From a practical sense – reflect on how you feel after a fight with a spouse or family member. Don’t you feel better after sleeping on it for a night?
As always, we will be watching as new policy unfolds and make changes as necessary to the underlying holdings in our portfolios should they be warranted. We will continue to communicate with you in a timely manner, ensure your asset allocation remains aligned with your risk tolerance and ensure your portfolio is constructed in a manner designed to meet your needs over the long-term.
Investment advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Nexa Financial Group are separate entities.The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
