Here is the transcript of the video above:
It’s getting to be that time of year – every 4 years actually – when the upcoming presidential elections can cause some very powerful emotions and get investors anxious and sometimes nervous. Compound the elections this year with the COVID crisis dominating the news, it could make for some volatile times in the market.
In this video blog, we will discuss the upcoming elections and the effects on the stock market and what you should be doing with your portfolio.
When I was doing research for this article, I came across two different data points. One had to do with the correlation of each political party and the effect on the market. The second had to do with the years of a presidential term and the effects on the market during each of those 4 years.
While yes, the Presidential race is important (for numerous reasons this year), in my opinion, the races in the House and Senate are just as important. First, let’s take a look back at the last 81 years and the growth of the S&P 500, based on which party is in the Presidency:
The line I get from clients at times, is that “it is different this time” and that this election will influence the market. While I don’t disagree that we have a lot going on in our county and the moment, if we go back over the past 11 elections, there was always some sort of headline news going on at that time, for example:
There’s nothing wrong with wanting your candidate to win, but investors can run into trouble when they place too much importance on election results. That’s because elections have, historically speaking, made essentially no difference when it comes to long-term investment returns. Presidents get far too much credit, and far too much blame, for the health of the U.S. economy and the state of the financial markets. There are many other variables that determine economic growth and market returns and, frankly, presidents have very little influence over them.
Now that we talked about the presidency, let’s talk about the House and the Senate races and which mix has given the best returns for the markets historically.
Now that we have covered the political parties and their correlated returns, let’s now shift to the presidential cycle. The "Presidential Cycle," shows a consistent pattern in which the first 2 years of a presidential term have tended to produce below-average returns while the last 2 years have been well above-average.
Presumably, the reason for this is that during the first half of a term, a president's new agenda could take some time to work its way through the economy. It might even produce some indigestion for the market if it's not considered "market friendly."
But during the last 2 years, the party in power tends to be more inclined to focus its attention on getting re-elected, or so goes the general thinking. It presumably does this through fiscal stimulus and even monetary stimulus (at least it could have until the Fed became independent in 1951). This gooses the economy and creates a big rally that, presumably, is intended to ensure re-election of the incumbent party (or at least that's the goal).
Short-term differences, long-term similarities
What's interesting to note is that whatever the differences are in outcomes over the first 2 years following a presidential election (and there are many), they have all but disappeared by the time a full 4-year term has taken place.
For instance, on average over the 2-year period, the market does better following a Republican win (+8.3%) than a Democrat win (+5.8%), but over a full 4-year term the average difference virtually disappears and we are left with +8.6% vs. +8.8% for Republican presidencies and all presidencies respectively.
The contrast is even more extreme when there is a sweep. When the Republicans sweep, the 2-year average forward return is +12.2% and when the Democrats sweep it is a mere +3.4%. But again, after 4 years the difference in average returns is almost gone (+8.6% vs. +8.2%).
It always comes back to fundamentals
But it could also just be that if you wait long enough, the long-term fundamentals of earnings and interest rates, labor growth and productivity, and the mean-reverting nature of an independent monetary policy, take over in driving long-term returns.
It's a good reminder that while it is sometimes suggested that a particular president or party is "good" or "bad" for the stock market, ultimately, it's these long-term fundamentals that matter. While policy initiatives like taxes and spending can affect markets, so do demographics and an effective monetary policy.
From a longer-term market perspective, the upcoming presidential election is of course important, as the approaching demographic wave of an aging population increases demand for health and Social Security benefits, which are likely to result in ever-rising debt levels and the need for permanently low interest rates.
Nevertheless, it's my personal sense that the 2020 election will have less impact on the markets than some suggest. Ultimately, it's the long wave of economic fundamentals that drives the markets beyond any one election or any one party.
Investing during an election year can be tough on the nerves, and 2020 promises to be no different. Politics can bring out strong emotions and biases, but investors would be wise to put these aside when making investment decisions.
Don’t allow election predictions and outcomes to influence investment decisions. History shows that election results have very little impact on long-term returns. In fact, according to a 2019 Dimensional Funds report, the market has been positive overall in 19 of the last 23 election years from 1928–2016 or 83% of the time, only showing negative returns four times
Expect volatility, but don’t fear it. View it as a potential opportunity.
My advice to all our clients, is to stick to a long-term investment strategy instead of trying to time markets around elections. Investors who were fully invested or made regular, monthly investments did better than those who stayed in cash in election years. I do encourage everyone who can, to get out and vote. As Thomas Jefferson once said, “We in America do not have government by the majority. We have government by the majority who participate.”.