Elections and the Stock Market: Much to Do About NothingSubmitted by Younity Wealth Partners on November 7th, 2016
Updated: November 7th, 2016 by Kara Downing, CFP®
As the end of this particularly polarizing election season draws to a close, there is no question that the election and its impact on the stock market is top of mind for most investors. As was the case in prior elections, invariable stock market correlations seeking to predict election results or forecast the market’s direction have been plentiful. On one hand, the performance of the stock market during the three months leading up to the election has been somewhat of a predictor of who will win the race. On the other hand, we try to predict the direction of the market based on who wins the election. As much as we would all like to glean even a small amount of investment insight from the election year follies, it would be important to note that the stock market is essentially non-partisan, and Presidents have very little impact on the direction of the markets. As those who follow our investment philosophy already know, the markets are random, but they do work regardless of which party is in office. Principled and disciplined, long-term investors don’t invest for an election cycle, they invest for a lifetime.
The Stock Market as an Election Predictor
Predicting what will happen in the stock market is impossible. But in light of today's historic Election Day vote, we took a look at what happened in the markets over the past few decades in relation to US presidential elections. But before we get to that, though, it's important to remember that the past does not predict the future when it comes to markets. And so we are not making any predictions here about what will happen on the morning of November 9, 2016, or thereafter. (And if someone tells you they have a foolproof way of doing that, it's time to make a run for it. Quickly. In the opposite direction.) Still, it's an interesting exercise to sift through historical data to look for specific patterns.
The polls are showing Democratic contender Hillary Clinton as favored winner in tonight's election, but the S&P 500 stock market index begs to differ. Admittedly, the stock market has been fairly successful at predicting the results of Presidential elections. Since 1900, the performance of the S&P 500 between July 31 and Election Day has correctly predicted the winner 88% of the time. 82% of the time when the market rallied between August and election day, the incumbent won. 86% of the time when the market declined, the challenger won. That’s 25 out of 28 elections that the stock market has, in effect, selected our President. If history follows this formula, it's pointing to a victory by Donald Trump this year. The S&P 500 is down 1.81% from the end of July through November 7.
There is some logic behind this relationship. The basic idea is that if the economy is growing and people think the good times will continue, they are likely to want to stick with the same presidential party (in this case the Democrats). If they are fearful, stocks tend to fall, and voters want new leadership. Of course, politics is hardly the only factor driving the stock market. There's a lot more attention on the Federal Reserve's possible December rate hike and the deluge of corporate earnings. If anything, the political factor influencing the broader market is concern that Clinton will win AND the U.S. Senate or House could go to the Democrats. Investors prefer divided government, which leads to fewer changes in laws.
The Election as a Predictor of Market Direction
Each election year, I am asked whether a win by either party will be better for the stock market. And each election year, my response is the same: "Market forces are much more powerful than any single person, even the President of the United States." With a slowing global economy and the possibility of increasing interest rates, the market already has enough to absorb. All told, there have only been three election years of the last 21 in which the S&P 500 had a negative return.
Is the Stock Market Pro-Republican or Pro-Democrat?
If we try to apply any logic to this, we would have to surmise that the stock market should perform better with a Republican in office. After all the markets like free-enterprise, lower taxes and less regulation, right? Try telling that to George W. Bush. The stock market lost 25% during his two terms as President. Of course, he had two recessions and two stock market crashes as bookends to his eight years in office.
Conversely, the best stock market performance under a two-term President was none other than Bill Clinton who actually increased taxes. It can be said though, that the stock market performed extremely well under Ronald Reagan albeit for two down years (1st and 7th years of his presidency). But now, we have Barack Obama, under whom taxes and regulations have increased significantly, and the democratic candidates are putting proposals for more tax increases are on the table. Yet, of the last five Presidents, his first-term has seen the biggest four-year return of 46.5%. Of course, his first term began just as the stock market hit bottom after the 2008 crash.
The final tally shows that the best stock market performances in the last 30 years have come under democratic presidents. Yet, nothing they have done while in office can be remotely linked to the performance of the stock market.
The Final Analysis:
Yes, investor sentiment in the immediate aftermath of the election can affect the market. And, yes, presidential policies affect the economy, which then in turn can affect the markets. However, there’s too much noise embedded in a stock market move to isolate investors’ opinion about a political race. Plus, we should note that the US stock market is not the US economy.
Emotional responses to political shocks are quite typical of investor (and, more broadly, human) behavior. But as history has shown time and time again, it is best not to deviate from a well-thought-out, long-term investment strategy, as these events generally do not have a sustained impact on markets. While the election itself is stirring up a lot of emotion, investors stand a much greater chance of being rewarded when they take a more dispassionate view when it comes to an election's short-term impact on their portfolio.