How will the Stock Market React to the Presidential Election?Investment
With both the Democratic and Republican national conventions in the rear view mirror and candidates hitting the campaign trail, more and more attention is turning toward Tuesday, November 3rd.
While there is much debate about which candidate will prevail, there is also no shortage of theories about what a Trump or Biden victory could mean for the stock market.
We've Been Here Before
This debate isn't unique to the 2020 U.S. presidential election, similar questions arise every four years. And sometimes, the election results coincide with large market moves. Many will recall that the futures market had the S&P 500 index down more than 5% the evening of the 2016 election, only to finish in positive territory the day after the election.
As investors are constantly bombarded by headlines about the latest polls and suggested policy or tax reform, it's easy for them to take all this uncertainty, boil it down to a single event like an election and worry about what it could mean for their portfolios.
How Does the Stock Market Behave Around Elections?
We have data for 23 presidential elections through 2016, going as far back as 1928 when Herbert Hoover won. This isn't a very large sample size, but we aren't trying to get too precise with our analysis, so bear with us. We looked at returns in the three months leading up to the month of the election (August through October), and both the three months and six months after the month of the election (December through February and December through May) for all 23 elections. Figure 1 illustrates the results.
What do we find? On average, returns are positive in all three periods for the 23 election years but returns vary widely. For example, the average return for the six month period following the election month is about 7.5%, but the range goes as far as about -14% to more than +56%.
Figure 1 | Stock Market Returns Have Varied Widely Around Elections
CRSP US Total Market Index* Returns Before and After US Presidential Elections (%)
In Figure 2, we show the same data but with the winner of each election and his party (red for Republican and blue for Democrat). Let's zero in on one former commander in chief to put the chart into context. Franklin Delano Roosevelt (FDR) was victorious four times, first in 1932. The average return for the six month period following his victories was 15.8%. Composed of two positive six month periods and two negative six month periods.
But again, averages don't tell the whole story. For example, if we take out the period following his first victory, which includes the spring of 1933 - a period often pointed to as the beginning of the recovery from the Great Depression - that average falls to just 2.3%.
Why is that important? Those four elections had a lot in common - the same individual running, same party, etc. - but vastly different results following each election. This reinforces the importance of looking beyond the election.
The Big Picture
While policy decisions and the regulatory environment no doubt have an impact on the economy and markets, these are only a few among a long list of factors. Investors are individually and collectively assigning probabilities on these and other inputs as they agree to buy and sell securities in the market, building expectations about the future into current market prices.
What's the takeaway for investors? While the election will dominate headlines over the next couple of months, don't worry about its impact on stock market returns over the longer term. Investors should review their investment policy statement and strategic asset allocation targets to confirm they are still appropriate. Rebalance your portfolio back to strategic target when it has drifted to avoid unwanted risk. Four years ago we wrote; Election 70 Days and Counting: Presidents, Politics and Your Portfolio, which is as relevant today as it was then:
"The more heated the politics, the more important it is to establish and maintain a well-planned, strategic long term approach to managing your investments."
Regardless of your expectations about the election outcome, step back and think about the bigger picture. What does your long term financial plan look like - has it been designed with uncertainties around these sort of events and market volatility in mind.
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