It is officially election season. We are 12 weeks from election day and today Joe Biden selected Kamala Harris as his running mate. The next three months we can undoubtedly expect to get bombarded on all sides with talk about the upcoming presidential election. There are almost no aspects of our lives that are immune to the prognostications of the dire impact of one candidate or the other getting elected, and the stock market is certainly no different.
In the midst of the Coronavirus, with the market coming off the fastest bear market and subsequent recovery in history, trillions of dollars of spending, and interest rates bottoming out, the biggest concern we are most commonly hearing from clients is STILL about the upcoming election. Inevitably it comes down to the same basic idea: if my candidate wins the economy will be great and stocks will go up, if my candidate loses everything will fall apart and the stock market will sink.
Since the President does make very meaningful decisions that undoubtedly impact the economy, this line of thinking isn’t totally irrational. With that in mind, I thought it could be helpful to strip away the politics and look at the data. Does the market react predictably based on the party of the candidate, and should you adjust your portfolio depending on who wins the election? The other thing we often hear is that some powers that be are artificially propping up or holding back the stock market during the election year to try to sway the election, with the expectation of a drastic move in the other direction once the election is over. The first thing worth looking at is if the stock market performs markedly better or worse during the year of an election or the year following. Below is a chart a showing the returns of the S&P 500 during these years. 1
The overall return of the S&P during this period was 9.8%. The average return during election years and during the subsequent year were 11.3% and 9.9%, with plenty of volatility. If there was truth to the above speculations, we would consistently see extraordinarily high or low returns during election year followed by a reversal the following year. The data does not bear that out, and there is nothing in the above data that should lead an investor to make any tactical changes to their portfolio during or after election years.
The next question which we most often get relates to the performance of the market when a certain party is in power. Many people assume that the market will respond better or worse based on the economic policies associated with one party or the other. Fortunately, we don’t have to go on gut feel or anecdotal memory; there is good data on market returns going back nearly 100 years that we can evaluate to test this hypothesis. So is there any truth to the idea that markets can only perform well if a certain party is in the white house?
I’ve included 2 graphs below showing the breakdown of returns based on party. 1
Now you can slice and dice the numbers in many different ways to try to fit a narrative, but what is very clear is two things: It is difficult to attribute predictably superior returns to one party, and more meaningfully, it would be foolhardy to think that the market can’t make money if the “other” party is in office.
However, all of this data ignores one factor that actually DOES impact investors’ performance in relation to presidential elections: Behavior. One research study found “that individuals become more optimistic and perceive the markets to be less risky and more undervalued when their own party is in power.” This affects investors’ portfolio decisions and as a result, “investors improve their raw portfolio performance when their own party is in power.”2 As shown above, the market tends to increase regardless of which party holds the white house, so those more optimistic and willing to invest in the market have outperformed those that are more pessimistic and less willing to invest.
The 2016 election was a great example of this. Many financial experts and talking heads were predicting a decline in the market if Trump won. On Fortune.com, Katie Reilly reported that Citigroup predicted that a Trump win would have a negative effect on the stock market, believing the S&P 500 index would fall 3% to 5% if Trump was elected. Evelyn Cheng reported on CNBC the day before the election that JP Morgan, Barclays, Citi, and BMO all expected a Trump victory would have a negative impact on the stock market, with Barclays being as bold as saying the S&P 500 could potentially fall 11 to 13 percent. Some went even further with their market predictions. Simon Johnson of MarketWatch wrote:
“The election of Donald Trump…would likely cause the stock market to crash and plunge the world into recession.”
In an interview with Neil Cavuto, noted billionaire Mark Cuban stated:
“In the event Donald wins, I have no doubt in my mind the market tanks,” Cuban said. “If the polls look like there’s a decent chance that Donald could win, I’ll put a huge hedge on that’s over 100% of my equity positions… that protects me just in case he wins.”
To the surprise of these pundits, the opposite occurred. In just 2 months from November 1st through the end of the year, equity markets had a substantial growth period, with the S&P rising 6%, the Russell 2000 up 14% and the Russell 2000 Value increasing by 18%.
There are a few main takeaways from this data:
- There is no real correlation between the political party in the white house and stock market returns. No matter how much you may fear the policies of the other party, companies generally still find a way to make profits and produce positive market returns.
- The stock market was consistently and predictably positive over the course of a presidential term during the entire time period, with the only exceptions being a result of the great depression, the tech bubble popping, and the great financial crisis.
- Your behavior, not the result of the election, is more likely to impact the performance of your investment portfolio.
1 Source: Dimensional Fund Advisors
2 Source: “Political Climate, Optimism, and Investment Decisions” Yosef Bonaparte, Alok Kumar, Jeremy K. Page
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