By Dr. Chenjiazi Zhong, CFA, CAIA, FRM+
- Investors should be careful making investment decisions based on expected election outcomes
- The stock market has generally performed well during presidential election years, particularly when the incumbent party wins
- Fundamental factors, such as oil prices, corporate earnings, and monetary policy, should outweigh political developments
- Sectors such as health care and energy could be affected by proposals of leading candidates.
The U.S. stock market has historically generated gains in presidential election years. However, we caution investors against making investment decisions based on expected election outcomes, as more traditional issues typically determine market performance.
Global growth trends, divergent monetary policies, volatile oil prices, corporate earnings, and geopolitical tensions are among the factors that are more important than political developments. It may be tempting for investors to try to link presidential election results to market outcomes, but there are no consistent relationships between party affiliation and long-term investment success. It is fairly hard to predict the outcome of politics, and even if you get the outcome right, it is even harder to predict the market reaction, so you're doubling up your difficulty. It is like trying to thread the needle twice.
Stock Market Has Favored Republican and Incumbent Party Victories
Average Annual Principal Return for S&P 500 Index in Presidential Election Years: 1928-2012
Source: Strategas Research Partners
History Provides Contradictory Clues
Indeed, you can find evidence supporting betting on either party. On one hand, from 1945 through 2015, the S&P 500 Index generated an annualized principal return of 6.7% over the course of Republican administrations and 9.7% during Democratic administrations.
On the other hand, since 1928, the U.S. market has fared better during election years when Republicans have won, recording an average gain of 11.3% in Republican-year victories, compared with 3.3% when a Democrat won the White House. The severe decline during the global financial crisis in 2008 was the only bear market election year during this time. The S&P 500 Index advanced in 16 of the 22 presidential election years since 1928.
Further complicating the picture, the S&P 500 Index generated an average annual gain of 11.6% when the incumbent party won over this time period versus 0.3% when it lost. In the 17 presidential elections since World War II, the index gained an above-average 9.7% when the incumbent party won, compared with a below-average gain of 2.2% when it lost.
Investors only have to look at last year to see why such historical results are not predictive. The third year of a presidential term has historically been the best year for market performance, yet the S&P 500 Index generated a gain of only 1.4% in 2015, including dividends. For two-term presidents, the final year in office marked the worst market performance of their eight years in office.
Policy Changes Could Impact Markets
Investors would do better to focus on the individual policy initiatives represented by each candidate and how they could impact the economy and financial markets. The election could affect creditworthiness of companies operating in certain highly regulated sectors, such as energy and health care. If the new president and Congress were to change or repeal the Affordable Care Act, as some candidates have espoused, that would have implications across the spectrum of health care companies.
Annual S&P 500 Price Performance in Election Years: 1928-2012
Source: Strategas Research Partners
In fact, health care stocks have been underperforming since last fall partly because the issue of drug price controls has gained momentum from both political parties. The possibility of controls is definitely making investors more nervous.
Most forecasters have not changed their U.S. growth estimates this year based on politics. Certainly the election outcome is not immaterial for financial markets and economic prospects. We could see more financial market volatility that could affect the economy as the campaign progresses.
In particular, leading candidates favor free trade restrictions and more protectionist policies that could harm U.S. and global growth. In most cases, trade benefits all economies that engage in it. Generally, what trade allows is for economies to specialize in what they are good at and allocate resources well, so you get the broadest possible selection of goods and services available at the lowest prices. The market probably would react negatively to the imposition of tariffs. No one wins in a trade war.
Amid global economic headwinds, the Fed will continue to move gradually in its pursuit of rate normalization, with one or two additional rate hikes this year. There are not that many times during a presidential election year that it was appropriate for the Fed to raise rates. In terms of holding off on raising rates, it was a Republican Fed chairman, Alan Greenspan, who raised rates in the summer of 1988 within a week or so of the Republican national convention, so the Fed does what it needs to do. Republican George H.W. Bush went on to defeat Democrat Michael Dukakis in the general election. Democratic Fed Chair Paul Volcker also raised rates considerably during the Carter administration.
The big macroeconomic trends such as weak oil prices and global growth are driving rate levels. The election debates and even some of the candidates' ideas are too far out in the future to have much impact on the interest rate picture today, and interest rates are so low globally that there is not a lot that could be done now that would cause a dramatic shift.
As the presidential campaign unfolds, speculation over how the outcome might impact markets and businesses will surely intensify. We advise investors to simply maintain a diversified investment portfolio that could provide reasonable returns over time regardless of the political environment.
With risks to global economic stability rising, investors should be compensated up front for the growing and heightened uncertainty and potential consequences of monetary policy exhaustion they face. Under a left tail scenario in which this stable disequilibrium unravels sometime and in some fashion during the secular horizon, no one has a crystal ball to determine what it would look like. The timing and precise dynamics of the eventual endgame following such a scenario are uncertain, the plausible paths are many and complex, path dependence would be the rule and not the exception, and much would depend on the timeliness and boldness of the policy, including fiscal policy. While there are myriad uncertainties, there is no doubt that a global disruption of the baseline scenario would have serious repercussions for growth, inflation and financial markets. The risks are uncertain, but they are real, and active investors can aim to put a price on them.
 Source: S&P Global Market Intelligence
 Source: Strategas Research Partners
 Source: Ned Davis Research
 Source: Ned Davis Research