Whenever a US presidential election rolls around, it's not uncommon to hear it described as "the most important" in our lifetime in an effort to rally voters to go to the polls. In many respects, the outcome of the election can feel like a momentous sea change in American life, as whoever wins control in Washington, DC, will be in charge of setting the agenda for our government.
Given how significant these elections can feel, it's natural as an investor to assume that the outcome could have a major impact on the financial markets. Each party has its own agenda and will be offering up a slew of proposed policies that seek to address issues of great economic import, like taxes, trade, and health care.
Whether you agree or disagree with the plans put forth by the party in power, you may feel compelled to make changes in your own portfolio to either take advantage of, or protect yourself from, the market moves you expect to take place in the wake of the election.
Historically, however, financial markets have largely been unbothered by both presidential and mid-term elections, and trying to adjust your investment strategy in the hopes of capitalizing on an anticipated post-election swing in the markets could end up backfiring on you. “If you’re an investor, I would suggest that this shouldn’t be something you focus on,” says Denise Chisholm, director of quantitative market strategy at Fidelity Investments. “It’s my belief that you shouldn’t be making big changes in your portfolio because of an election.”
Focus on the fundamentals
Naveen Malwal, an institutional portfolio manager with Strategic Advisers, LLC, the investment manager for many of our clients who have a managed account, agrees. “Historically,” says Malwal, “we haven’t seen a strong relationship between Election Day outcomes and how markets perform from there on out. As a result, we don’t adjust our positioning based solely on election outcomes.”
"It can be tempting to attribute market volatility to politics, but this year, as in most years, market performance is not so neatly tied into election cycles or political developments," says Malwal. "While political headlines may at times cause short-term ripples in the market, long-term, for stocks, bonds, and other investments, returns seem to be driven much more by the fundamentals of the underlying asset classes."
As such, Strategic Advisers, LLC, is more focused on economic fundamentals. "We pay attention to interest rate levels, as they may facilitate or restrict economic growth, the job market, which can be a good indicator of the strength of the consumer, and business activity such as inventory levels. For example, if we're seeing warehouses filling up with goods that consumers are no longer purchasing, that might be a sign of slower growth," says Malwal.
Looking at the historical data
“The election cycle is usually not the dominant theme of the market,” says Chisholm. In analyzing how markets have performed across election cycles, Chisholm looked at historical data since 1950, tallying up the price returns for the 12-month periods between federal elections.
"Looking at the historical data, it appears that while the 12 months preceding a presidential election have had the widest range of possible market outcomes relative to other parts of the election cycle, the average return isn't substantially better or worse. Generally speaking, this points to the presidential election not being a notably 'market moving' event," says Chisholm.
“Historically, we’ve seen the best average returns in the 12 months following the midterm elections," says Chisholm. The worst average returns with the highest variability in outcomes historically have been in the 12 months preceding the midterm election. The returns are still positive, just not as high. So, in the past, what we’ve seen is the 12 months following the midterms tend to have the least amount of variance, and the least amount of downside.”
Chisholm says this could be because the resolution of the uncertainty surrounding the election calms investors, but overall feels that markets are largely taking their cues from other developments. “The wide range of outcomes you see in the analysis highlights that it’s probably not politics that are driving stock performance. How markets react is likely going to be driven by inflation, how strong earnings are, whether investors expect a recession or not, or by what the Federal Reserve does. Politics likely won’t have much of an impact.”
Adds Malwal, “When managing client accounts, the US business cycle is the primary driver of our investment decisions. That’s because we believe the pace of US economic growth and the direction of corporate profits are much stronger drivers of stocks over the long run.”
Don't overreact to campaign promises
Malwal warns against putting too much stock in the proposals made by candidates in the coming year. "There are dramatic differences between the proposals expressed on the campaign trail and the actual policy changes that take place once the candidate is in office," says Malwal. "It's exceedingly rare that a candidate will be able to deliver on exactly what they've proposed once they take office. If you're making investment decisions based on such proposals, that could be a risky way of managing one's money."
"Heading into an election, whether you're optimistic or pessimistic about the outcome, that's probably not enough of a reason to make a drastic shift to your long-term financial plan," says Malwal. "We believe such a plan should be based on an investor's goals, their risk tolerance, and other considerations regarding their specific situation as an investor or as a family. But we don't believe market history supports factoring in election cycles when managing long-term investments."
"It's almost never a good idea to make a decision based on an individual data point," says Chisholm. "You have to be very careful about assuming that any angst surrounding the upcoming election may be predictive of future returns. If anything, the more angst you feel about the situation, the more likely it is that markets have already priced it in. In that case, it may already be reflected in market performance, which means markets may be less likely to experience volatility when what you're concerned about comes to pass."