A Deadlocked Election Should Scare Investors

A hung election could spur a Wall Street drop.

Romney and Obama battle during the presidential debate at Lynn University.

Children throughout the country will be wearing Obama and Romney masks for Halloween—and those are two faces that really scare investors.

The reason for that fear has to do with the closeness of the presidential race, not the candidates' policies. The last thing Wall Street wants to see is an undecided post-election period like the Gore vs. Bush 2000 race that was ultimately decided after the fact by the Supreme Court.

"My Halloween nightmare is a hung election," says David Edwards, president of Heron Financial Group, a wealth management firm. "If that's what we get, stocks will drop 10 percent."

Even with the polls tightening, it's not the most likely scenario. But mounting uncertainty has already played a role in putting an end to the stock market's bull run. Back on October 2, when President Obama seemed to have the election all but won, the Dow industrials were at a multiyear high of 13,650.

Then came the first debate, and the president's surprisingly weak performance, which led to an overnight tightening of opinion polls. The Dow has shed 500 points since then, as Obama's lead began to vanish. It's not because investors favor the president. But they do like certainty.

[Read: Are Brawling Politicians Bad for Your Portfolio?]

"This election is on a real knife edge," says Edwards. "Investors like certainty and they dislike uncertainty—and that's what elections are all about. We have two candidates who are very different, and this election is getting closer as we reach the finale."

Obama and Romney represent much different approaches to the economy, taxes, healthcare, and a range of issues critical to businesses and investors. Decision-makers want to invest with a clear view of the future, regardless of who wins the White House. A hung election, in which neither candidate wins the 270-vote majority of the electoral vote, would prolong the uncertainty. It puts the decision in the hands of Congress and, more importantly, it would launch a new administration into a new term without being elected in the voting booth. That would be a shaky mandate at a time when Washington's deep political divides have already paralyzed progress on critical decisions. For a glimpse of the possible impact, remember that the battle over the deficit ceiling last year was a key factor in Standard & Poor's decision to downgrade the U.S. credit rating.

Undecided "purple" states, home to stressed-out investors. Research shows that U.S. investor confidence never fully recovered from the financial collapse of 2008 while George W. Bush was still president. Wealth research firm Aite Group reported in October that investors in political "swing states" are the most fearful about the market.

"What you see in the purple states is much higher dissatisfaction or lack of confidence in equity markets," says Javier Paz, senior analyst for Aite. "That higher incidence is problematic for the incumbent [Obama] and could turn on him, particularly in swing states like Florida and Ohio."

Florida, the key swing state in the last "hung election" back in 2000, is again locked in a very close race, and the state's business owners and investors are "hesitant to let go of money" with consumer confidence low, according to a leading trade group's chief.

"From an economic-growth standpoint, a job-creation standpoint, and a capital-formation standpoint, people are always concerned around an election," said Rick McAllister, of the Florida Retail Federation in a video interview on Tallahassee-based Capital Dateline Online. "One side or the other is concerned over so-and-so getting elected or re-elected."

Adding to the "scare factor" is a tactic used by both sides of painting the other party's candidate as an economic bumbler. Researchers have reported the highest-ever levels of negative political advertising. A Supreme Court ruling two years ago overturned legal limits on political action committees, unleashing the tirade of negativity.

[Read: Is Congress Ruining Stock Prices?]