“As election season heats up, the average investor should think twice about making adjustments to his or her portfolio purely in response to election results.” – Peter Lazaroff, Forbes Contributor
Today we’re taking a slight departure from any semblance of serious financial commentary and discussing one of those topics that is sure to bear little to no fruit – if not end up being downright counterproductive. That’s right...it’s time to talk politics! More specifically, let’s prognosticate what might happen to the financial markets in response to a Trump or Clinton victory one week from today. Not only does this sound like a real gas, it’s also the #1 (and perhaps the only) question we’ve received from clients and colleagues over the past several weeks. We’re on the home stretch of election season, and everything else just feels like a bit of a sideshow for the time being.
In all seriousness, most of us feel that the outcome of next Tuesday’s election may have titanic implications for the future of our country. Most people I’ve spoken to are not overly excited about the prospects of either a Trump or Clinton presidency. But regardless of which political camp you find yourself in, or how you feel about our current candidates, many people are wondering how a Trump or Clinton presidency would impact the economy and more specifically, their personal portfolios. As readers of our Weekly Insight already know, we are always hesitant to prognosticate. We can’t predict the future, and we think you should be wary of anyone who seems to believe they can. That said, when it comes to the question at hand we can at least look back through history and see if there are any identifiable patterns that might be worth calling out.
The first that I’d like to highlight is that election years, in general, tend to be positive for the stock market. As pointed out in a recent Kiplinger article, since 1833 the stock market has gained nearly 6% in election years vs 2.5% and 4.2%, respectively, in the first two years of the presidential cycle. There are a couple potential reasons for this, but the mostly likely in my mind is the general lack of activity in election years on the part of congress and the Fed. Policy makers don’t like to be seen as trying to influence an election’s outcome, so most of them end up sitting on their hands in the year leading up to an election. This reduces the number of potential changes rippling through the system and creates an environment of status quo. And if there’s one thing the stock market likes it’s status quo.
Secondly, there is little to no evidence to support the expectation that the stock market will do better while either a Republican or Democrat is in office. Stocks are influenced by so many different factors, including earnings, valuation, sentiment, monetary policy, credit cycles and the overall economy (which itself is a poster child for chaos theory). Whether or not the residing president has an R or a D next to his or her name has little to no bearing on what happens to stocks over a very short window of four years. Historically the market has actually done better, on average, under Democratic regimes, but we have to be careful not to assign causality where the results are better chalked up to random variation. As stated in a recent Forbes article,
There is no conclusive evidence suggesting the president’s party has any statistically significant impact on U.S. equity market returns (see Campbell and Li 2004).
The stock market is a complex adaptive system in which cause and effect are not easy to link. Market movements, particularly over short periods such as a presidential term (yes, four years is a short-term investment period), are random.
To clarify, we’re not saying that the president has no impact whatsoever on the economy and financial markets. But the president’s influence is one of many, and is certainly not the most important. Furthermore, the types of policies driven by the oval office might not take effect immediately and can often ripple their way through the economy and financial system for decades. All of these realities make it that much more difficult to ascribe any particular period of market performance to one president’s influence.
Perhaps what I found most interesting as I researched this topic was that even though there is no evidence to suggest the occupant of the White House has any predictive power over what the stock market will do, there is actually some merit in using the stock market to predict who will win the presidential election.
A gentlemen by the name of Sam Stovall at CFRA Research suggests that the stock market’s performance in the three months leading up to Election Day can tip us off as to who will come out on top. According to Stovall’s logic, if the market has gone up over those three months it means investors are optimistic and feeling good about where things are heading, thus the incumbent party will retain control of the White House (Clinton). However, if the stock market has gone down over those three months there is widespread discontent and the other party will be handed control (Trump). As silly as it sounds, this simple indicator has had an 86% success rate over the past 22 elections. From the same Kiplinger article referenced above,
The statistics are compelling. In the 22 president elections since 1928, 14 were preceded by gains in the three months prior. In 12 of those 14 instances, the incumbent (or the incumbent party) won the White House. In seven of eight elections preceded by three months of stock market losses, incumbents were sent packing. ...the S&P 500 has an 86.4% success rate in forecasting the election.
So what has the stock market done over the past three months? Sorry, Hillary supporters…it’s down. But don’t worry, we’re confident the Donald will make the stock market great again!
Okay, so obviously the idea of such an arbitrary indicator calling a presidential election is a bit of a stretch, but if nothing else it may come in handy at your next cocktail party!
At the end of the day we simply don’t see any evidence to suggest that we should be adjusting portfolio allocations in one way or another based solely on an anticipated election outcome. Is the election incredibly important on a number of levels? Absolutely. Will the president have any influence over the economy and capital markets? Of course. Should we all be taking stock in this election? You bet. And we will certainly be watching things closely as they unfold over the next week, and in the months to come after the next president has been chosen. But in the meantime we will encourage our clients to focus their time, effort and mental energy on the few things they can directly control. Working hard, spending and saving wisely, sticking to a long-term plan and most importantly – exercising the freedom to pursue what makes their lives truly rich.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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