- Predicting stock market outcomes based on election results is not always straightforward. In general, economic trends are more impactful.
- The stock market starts pricing in information as soon as it's available. By the time a a long-anticipated event occurs, the market has often already discounted the impact and moved on.
- Most sectors may have already priced in potential election outcomes, says Fidelity's sector strategist Denise Chisholm.
- Currently, Chisholm sees opportunities in technology, consumer discretionary, and the energy sector.
Elections and your money
Presidential and congressional elections influence the direction of public policy. But how much do they impact your investments? If history is any guide, not as much as you may imagine.
"I think it's important to consider that there are bigger factors out there," says Denise Chisholm, Fidelity's sector strategist. "Certainly there have been over the last decade. And given the global pandemic and federal responses to it, that could be true for this election as well."
Viewpoints spoke with Chisholm about her sector outlook in light of the election and those bigger trends.
Do you anticipate different sector or market outcomes based on which party wins the White House and/or Congress?
Chisholm: The historic odds, as they relate to potential election outcomes and the markets, are very counterintuitive.
The Republican party has largely been perceived to be business-friendly. But when you look back historically, the stock market has done a little bit better on average under Democrats.
You can see this as well in sectors. If you split the sectors between defensive sectors (consumer staples, health care, utilities, and telecom) and economically sensitive cyclical sectors (financials, tech, consumer discretionary, energy), you'll see a similar theme in the average returns. Cyclicality has done a little better under Democratic regimes.
That doesn't mean that if a Democrat gets elected to the White House it's potentially better. It shows you that the market is a discounting mechanism. When market behavior is counterintuitive, however marginal, it often means there are other factors that are more critical drivers of the market.
Case in point: Take health care reform in the 1990s. Ironically, just as the rhetoric was heating up on health care reform in late 1992 and early 1993, health care stocks were bottoming relative to the market. This shows a second potential issue with using one variable—the market often discounts that variable in advance. Peaks in uncertainty are often correlated with positive future relative returns.
Read Viewpoints on Fidelity.com: Presidential elections and stock returns
Do you have any theories as to why cyclical sectors have historically performed better on average under Democrats than Republicans?
Chisholm: Historically, there's been more spending under Democrats in general. It's important to note that this is based on averages and there is a lot of variability around them.
On average, taxes tend to go up more during Democratic regimes than Republican regimes. And when taxes go up, more often than not, you see more government spending.
Investors might be surprised to learn that real GDP growth tends to be higher during years that taxes increase—whether it's personal, corporate, or capital gains taxes. It could be because the multiplier effect of government spending is higher than a potential one-time event in taxes. Or, it may be that administrations find it easier to raise taxes when growth is strong. Either way, it's worth remembering there is a historic positive correlation between taxes and growth.
The same can be said about the market. While it is true mathematically that higher corporate taxes lead to lower after-tax corporate profits, history shows that more often than not, market multiples expand to more than offset the hit. Digging through history shows that there is usually a significant level of fiscal stimulus that may allow the market to look through tax increases.
Read Viewpoints on Fidelity.com: History lessons from past tax hikes
Are there any sectors where you think the election really is the dominant factor this time?
Chisholm: While there are certainly going to be specific effects on some industries, the election may not be as dominant for sectors as investors think. Again, the higher the level of uncertainty, the more likely it is that much of the bad news (or good news) is discounted in advance.
Let's take energy as an example, which might be similar to health care in the late '90s. Democrats have a green agenda and that may be one of their dominant spending policies. So under a new administration, energy as a sector could be in the crosshairs.
But the data I look at already shows a significant amount of fear around the energy sector. Valuation spreads are exceptionally wide, which means that investors are fleeing stocks in the sector they view as risky and potentially taking refuge in stocks more aligned with a green agenda. That behavior is often associated with high odds of outperformance.
And those odds for future outperformance have been strong historically despite relatively poor and deteriorating fundamentals. That is a sign that much of the bad news may in fact be discounted. So for energy it may be something like we saw with health care—once we get past the election, and the uncertainty is past, the sector could rebound.
What is your sector outlook for the rest of the year?
Chisholm: There's no change in views based on the election because many of the odds I watch show it may not be the dominant driver. A more dominant theme may be the continuation of the economic recovery, which may continue to lead to a skew away from the defensive sectors like consumer staples, utilities, and real estate, toward the more economically sensitive sectors with technology as dominant leadership.
From a sector perspective I think that the 3 best for the rest of the year for risk vs. reward potential are technology, consumer discretionary, and energy. And the lowest in terms of risk vs. reward potential are the more classically defensive sectors like consumer staples, utilities, and real estate.
Do you anticipate any election-related volatility or recovery-related volatility?
Chisholm: Volatility does go up in both circumstances—emerging from a recession and in election years.
Since volatility may be a given, it's more important that investors have a plan for what to do when it happens.
The important point to understand is there's going to be increased volatility and you should stick to your financial plan despite it. Volatility is a known fact. You can either use it to your advantage and increase investments when it seems appropriate, or you wait, understanding that volatility is a known quantity and you look through it to the other side.
The world feels very unstable now. Do you ever think maybe it's different this time?
Chisholm: It literally always is different. All of our recessions are different and all elections are different.
And as much as it feels like things are very unstable in the time of coronavirus, I would bet that during the 80s things felt very unstable with interest rates at 20%.
So I think that things feel unstable during recessions, and that's the theme that tends to be dominant to the market. So the market discounts that instability in advance and acts and behaves a certain way.
As much as we want to think that the stock market is a direct reflection of the economy, or should be a reflection of the economy, it never has been.