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NEW YORK (Reuters) – A U.S. presidential race that is about to heat up could add a fresh wrinkle to markets in 2024, as investors gauge the potential for post-election changes in fiscal spending, taxation and other policy areas.

For months, the Federal Reserve’s monetary policy trajectory and the U.S. economy have consumed investors, with expectations for 2024 rate cuts by the central bank fueling an explosive stocks rally in late 2023 and putting the S&P 500 within striking distance of a fresh record high.

The importance of those factors for asset prices is unlikely to wane anytime soon. But with the Iowa caucus set to kick off the state-by-state nominating process on Monday, a potentially close race and sharp partisan divisions in the electorate could add unexpected twists to the path for stocks this year.

“The election is introducing an extra layer of uncertainty,” said Irene Tunkel, chief U.S. equity strategist at BCA Research.

This year’s election is pointing toward a rematch between President Joe Biden, a Democrat, and former President Donald Trump, who holds a commanding lead over Republican rivals.

However, any narrowing of the Republican field following the Iowa caucus “could also make for a more competitive race” for the party’s nomination, Goldman Sachs economics analysts said in a Monday note. Trump’s lead in the upcoming New Hampshire primary would shrink to around 3% if the field narrowed to him and former South Carolina Governor Nikki Haley, they said.

“Uncertainty tends to rise at the start of presidential election years, and that pattern looks particularly likely to hold in 2024,” the bank’s analysts said.

WHAT HISTORY SHOWS

A president seeking re-election, as Biden is this year, has in the past been concurrent with above-average performance for U.S. stocks. Since World War II, the S&P 500 has gained all 14 times in the year that a president has sought re-election, regardless of who wins, with an average total return of 15.5%, said CFRA chief investment strategist Sam Stovall. That compared to the index’s average annual return of 12.8% in that period.

Overall since 1928, the S&P 500 has gained about 7.5% on average in presidential election years, according to RBC Capital Markets.

Seasonal patterns in election years, however, suggest the ride is not always smooth. The first three months or so of an election year tend to be choppy for stocks, with the S&P 500 generally flat, said Keith Lerner, co-chief investment officer at Truist Advisory Services, who reviewed data going back to 1950. The three months ahead of Election Day in early November also tend to be volatile, Lerner said.

The seasonal pattern of election years “does provide another reason to be on guard for an early year pullback,” Lori Calvasina, RBC’s head of U.S. equity strategy, said in a note on Monday.

This year, tax and spending policies are among those investors will be watching. During his presidency, Trump enacted tax cuts set to expire in 2025, with Republicans expected to try to prevent that from happening.

Democrats and Biden, who enacted a wide-ranging law that seeks to promote clean energy and lower prescription drug costs, would be expected to pursue tax hikes on corporations and the wealthy while spending to expand the social safety net, such as childcare investments, according to Oxford Economics.

An economic downturn this year would likely increase market focus on the elections, said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.

“If the economy does start to decelerate and we potentially see a recession, then the fiscal response and who becomes the political leaders will become much more important to markets,” Miskin said.

Certain areas of the stock market could become particularly volatile as the race advances and policy proposals are fleshed out, including any related to healthcare costs, defense spending or energy regulations.

In the 2020 election, for example, solar stocks rose as Biden’s election prospects improved. Trump’s victory in 2016 sparked a so-called reflation trade that boosted a broad range of sectors on expectations of looser fiscal policy.

Some investors doubt the election will have a lasting effect on markets. One factor potentially moderating the impact is expectation of a split Congress following the election that limits more radical policy changes. While elections can bring some volatility, “the over-arching theme that matters the most is where are we in the economic cycle,” said Jack Janasiewicz, portfolio manager at Natixis Investment Managers Solutions.