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Elections and Market Behavior

Updated: Apr 19

Political elections have historically been a subject of a lot of volatility--in terms of policy ideologies and their corresponding relation to financial markets. But is all of this worry and volatility really justified? Our experienced team of financial planners and financial advisors don't necessarily think so, as outlined in the commentary below. Continue reading to find some shocking statistics and figures that will hopefully put your financial concerns at ease this election season.

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"Who wins the next election and/or which party presides over our nation the next four years is just a small piece of the prognostication puzzle."

It seems every four years we field a barrage of client questions and concerns regarding investment tactics as we head into the presidential elections. “Will stocks tank if the presidency changes parties?” or “Does the market treat republicans and democrats differently?” are just a few of the questions on investors’ minds during a presidential election year. We are told that this election is the “most important one ever” and we listen to all the arguments which suggest how voting for their candidate will inevitably lead to the economy and financial markets going up (and vice versa, by the way).

History: Does it enlighten or mislead?

Rather than dealing with specific arguments or “theories,” looking at the historical data seems logical as a good place to start. We’ll be examining the period from 1926 through 2019 and we’ll focus on the S&P 500 index performance along with election results. During this time, we’ve had 23 presidential elections. Over this entire time period the S&P 500 index has averaged 12.09%/yr. In election years only, it’s averaged 11.28%...a tad less, but not so much to warrant a radical change in investment tactics during these years of future leadership uncertainty.

It’s said markets like continuity so what happens when there is a change in leadership? When the presidency switched parties, the average annual return in election years was only 5.14%, a stark difference from the average return. Does this tell us anything upon which to base an investment strategy? Most likely not. Why? It’s difficult to pinpoint causation. Was the market down because the presidency switched parties or vice versa? Did the presidency switch parties because the economy and market was down? This chicken and egg dilemma gets further muddled when we examine economic cycles and market returns in the years following a leadership change. We won’t bore you with the details but suffice to say there’s nothing upon which to base an investment strategy change. Which party president is “better” for the market? From 1926 to 2019, we’ve had a republican president for 46 years and a democratic president for 48 years. The average return for the S&P 500 when we had a republican president was 9.12%. When we had a democratic president it was 14.94%.

This is HUGE difference! Does it tell us anything upon which to base an investment strategy? Most likely not. We all know that presidents don’t have as much power over the economy as most people think they do. Without the votes from Congress it’s tough for any president to put their platform into practice. When they do get their way by getting the votes via a unified government (presidency/house/senate all the same party) things seem to go pretty well. For example, under a unified republican government, the S&P 500 has averaged 14.52% versus 12.09% for the long term average!

So does this mean the markets and economies favor republican rule? Not so fast. Interestingly, the S&P 500 average return under a unified democratic government has yielded IDENTICAL RESULTS! Yes, a 14.52% average return for the S&P 500 (14.521% to be precise). And to further enlighten (or bewilder), the highest-returning S&P 500 average outcome has actually been generated when a democratic president has presided over a DIVIDED congress, coming in at 15.94%/yr. Do markets and the economy like checks and balances in Washington to make sure one party doesn’t have too much sway? Perhaps…but we’re not willing to bet our investment strategy on it.

Bottom line: It's Complicated!

To be sure, politics – and the policies which stem forth from those political platforms – do matter, but to hang one’s investment tactics solely on this data is a setup for financial disappointment. Take corporate tax rates for example. The Trump administration lowered the top rates from 35% to 21% in 2018 and the prevailing wisdom has been that this will spur corporate profits and lead the financial markets to the Promised Land. (Conversely, there is fear among many investors that Biden’s potential corporate tax rate hikes will do the opposite). How have the markets (S&P 500) done since Trump’s tax changes were put into effect? In 2018, a poor result (-4.5%). In 2019, a great result (+31%). In 2020 thus far, a very volatile so-so result (+4.4% as of 9/9/2020) which, most likely, is due to variables which have nothing to do with corporate tax rates.

How have markets fared with higher corporate tax rates? Prior to the Trump cuts, the highest rate has held steady at 35% since the early 90’s. Stock results? The 90’s were killer good. The next decade was horrible. And since 2010, very good. Can we conclude anything? Most likely not. How about economic growth? In Trump’s first 11 quarters as president, U.S. gross domestic product grew by an average of 2.6% - identical to the growth rate in the last 11 quarters under Barack Obama (and higher corporate tax rates).

Stock valuations (i.e. the price investors are willing to pay for an expected stream of future benefits from owning a company’s common stock) are another variable to consider when looking at election results data and stock market performance. The S&P was trading on historically lowly valuations in 1949 and 1953 ahead of the Truman and Eisenhower administrations, which oversaw 60% and 65% cumulative market upturns. Valuations were at rock bottom ahead of the Reagan terms, which produced 29% and 81% cumulative upturns. By contrast, George W. Bush came to power just as the tech bubble had driven valuations to “dizzying and disastrous heights,” leading to an average annual S&P 500 return during his tenure of -2.9%.

Our point is simple: Predicting the future direction of stock prices is a difficult, if not futile, undertaking which needs to incorporate a myriad of variables like fiscal policy, federal reserve policy and the level of interest rates, demographic shifts, debt levels, unemployment, technology and productivity trends, global trade flows, currency, inflation, and so forth. Who wins the next election and/or which party presides over our nation the next four years is just a small piece of the prognostication puzzle.

Our advice for investors is to not get distracted by issues over which they exert little control (such as proposed increases or decreases in tax rates) and focus on issues over which they have some control, such in the case of taxes might entail incorporating tax management strategies into their investing. The stock market is politically agnostic, so developing a longer-term plan that works regardless of who is in office – and sticking to it – is essential for long term financial success.

In the meantime, we suggest you turn off the news, watch some football or go for a walk, AND VOTE ON NOVEMBER 3. After all, this election, according to investors every four years, IS, “the most important one ever.”

- Your ISG Team

*The information throughout this presentation has been obtained from sources which ISG and our suppliers believe to be reliable, but ISG does not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor ISG shall be liable for any errors or inaccuracies, regardless of cause.

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