Dear Clients and Friends,
Given the volatility experienced during this final week before the U.S. election, we thought it would be helpful to review the historical relationship between elections and markets. In our research, we came across the following piece from Capital Group that we found insightful.
How much do elections impact the stock market and portfolio returns? Should elections even matter to long-term investors in the first place? These are the questions investors are facing as we approach November 3rd. To provide answers, we’ve analyzed more than 85 years of data and identified three ways that elections influence markets and investor behavior.
1) Markets have tended to predict election results
A simple stock market metric has correctly predicted the winner in 20 of the last 23 presidential elections since 1936 — a track record that might make even the top pollsters jealous. If the S&P 500 Index is up in the three months prior to Election Day, the incumbent party usually wins. If markets are down during that period, the opposing party typically claims victory.
Why is this? It’s because equities tend to look ahead and “price in” uncertainty — including that caused by an upcoming election.
When the stock market and the economy are strong, there is usually less motivation for a change in leadership. In those years, stocks may not need to discount the uncertainty, which often allows stocks to continue rising, further bolstering the incumbent’s chance of reelection.
When the political and economic climate are more challenging, there is a greater chance that the opposing party will win. The market discounts the added uncertainty of the election outcome and what policy changes may occur, which can lead to higher volatility.
What does this mean for 2020? As of today’s close (October 30th), the S&P 500 is essentially flat since August 3rd (three months prior to Election Day). In normal markets, this would indicate a very tight presidential race. Since 1912, only once has a president been reelected if he oversaw a recession within two years of the election. While this trend may be interesting, investors shouldn’t use it as an excuse to try to time markets. Historically, whether the incumbent wins or loses, election volatility has usually been short-lived and quickly given way to upward moving markets.
2) Gridlock or sweep? Equities have gone up either way
One of the biggest concerns investors have this election cycle is the possibility of a Democratic sweep of the White House and Congress. Many assume this so-called “blue wave” will lead to a reversal of policies like deregulation or the Tax Cuts and Jobs Act of 2017. While it’s true that a new party typically brings its own policy agenda, assuming such an outcome will lead to meaningfully lower stock prices is probably over-simplifying the complexities of stock markets.
History shows that stocks have done well regardless of the makeup of Washington. Since 1933, there have been 42 years where one party has controlled the White House and both chambers of Congress at the same time. During such periods, stocks have averaged double-digit returns. This is nearly identical to the average gains in years when Congress was split between the two parties. Historically the “least good” outcome has been when Congress is controlled by the opposite party of the president. But even this scenario notched a solid 7.4% average return.
What does this mean for 2020? This year’s election will almost certainly end in either a unified government under a blue wave or a split Congress, which could happen with either a Trump or Biden victory. Voters may have a strong preference, but investors should take comfort that both scenarios have historically produced strong equity returns.
3) Markets have trended higher regardless of which party wins the election
Politics can bring out strong emotions and biases, but investors would be wise to tune out the noise and focus on the long term. That’s because elections have, historically speaking, made essentially no difference when it comes to long-term investment returns.
Which party is in power hasn’t made a meaningful difference to stocks either. Over the last 85 years, there have been seven Democratic and seven Republican presidents, and the general direction of the market has always been up. What should matter more to investors than election results is staying invested.
What does this mean for 2020? Some have called the 2020 election the most important in our lifetime. But that has been said about previous elections and will be said again about future elections. This year has been unique in countless ways, but a look at past election cycles shows that controversy and uncertainty have surrounded many campaigns. And in each case the market continued to be resilient. By maintaining a long-term focus, investors can position themselves for a brighter future regardless of the outcome on Election Day.
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