Election Day in the United States will be here before we know it. And (hopefully) soon after, we’ll know whether President Trump will continue at the helm of the nation for another four years, or if former Vice President Joe Biden will be packing his bags for a January move to 1600 Pennsylvania Avenue.
When all the celebrations and concession speeches are over, we may know who the president will be, but what may be less clear to U.S. investors is how the stock market will react. In the months before every presidential election, I often get questions from clients concerned about the effect of election results on their investment returns. Will the market tank if the president stays in office? Will it tank if we elect a new president? If only the answer were simple!
As Jake DeKinder, CFA, head of global advisor communication at Dimensional Fund Advisors (DFA) points out in this recent video, many factors play a role in determining stock market performance in addition to whoever holds our nation’s top office. What about the leaders of other countries? What about corporate earnings, monetary policy, globalization, or even a global pandemic? Each of those factors and many more have the potential to move markets, making a direct correlation between the election and market returns very difficult.
While it may be interesting to think that election results could have a significant negative impact on the stock market, history points to a more positive story. According to DFA research, market returns for the S&P 500 on average have been positive both in election years and the year following. The story was similar for the MSCI EAFE Index, which tracks large and mid-cap representation across 201 Developed Markets countries (excluding the U.S. and Canada).
Research by the Bespoke Investment Group in 2019 showed that a president’s third year in office is historically the best, with the S&P 500 up 81.8% percent of the time since 1928. That’s compared to years one and two, which are typically ahead 56.5% of the time, and year four, the election year, when the S&P stays positive 72.7% of the time.
So, does it make a difference whether the president is a Republican or Democrat? Since 1929, the S&P 500 has performed better during Democratic administrations, with an average total return of 57.4% (vs. 16.6 for Republicans). However, as this article in Forbes mentions, no evidence exists to conclude that the markets performed better because a Democrat was in the White House. That’s because, as I mentioned before, many factors can influence returns, and often those factors may be hard to consider independently.
Interestingly, a report by Charles Schwab’s Michael T. Townsend discusses that the market’s influence on election outcomes may be more reliable. According to Townsend, when the S&P 500 has risen in the three months preceding an election, the presidential incumbent has generally won re-election; however, when the S&P 500 has fallen, the incumbent has generally lost.
Is This Time Different?
In working with clients, I’m often asked whether it’s possible that “this time, it’s different.” For example, investors reeling from the impact of the coronavirus pandemic earlier this year wondered if the sudden decline in the market was indicative of a “new normal.” Turns out, it wasn’t. While past performance is no guarantee of future results, history shows the markets tend to have ups and downs from time to time, but still manages to grow over the long-term.
Brad McMillan addresses this question in an article for Financial Advisor. In terms of the election, he says Joe Biden will likely raise taxes if elected, which would impact corporate profit margins, curb spending and place a drag on growth. But he also notes that this is a normal political cycle, and, as in previous elections, each party offers to raise or lower taxes. And, while each party tries to characterize the other’s plan as disastrous, the plans as implemented don’t make much difference in the grand scheme of the markets.
Hang in There
A slide in the DFA video shows that markets have rewarded long-term investors, with a few bumps, through a long line of U.S. presidents. So, if you’re wondering about the best way to protect your investments from negative shifts in the market, a long-term approach makes sense. In times of extreme change, remember to focus on what you can control, including how much you save, proper diversification, a goals-driven strategy, and prudent investment management.
The prospect of continued uncertainty may be making you nervous, and that’s understandable. News of a coronavirus resurgence and its economic impact, President Trump’s indication that he may not accept the election results, and the battle for control of the Senate are just a few of the concerns circulating in people’s minds right now.
We can never be sure how a single event, like a presidential election, will affect your portfolio, but we do know this: Dealing with uncertainty is one major reason why investors earn a return over time. If uncertainty didn’t exist, it wouldn’t make sense for investors to earn a greater return over time. Applying discipline, maintaining realistic expectations, and taking a long-term view will go a long way toward helping us all maintain our financial well-being as November approaches.
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