Stocks And The Presidency: What To Expect When You're Electing

by: Eric Parnell, CFA

In just a few days, Americans will cast their vote for the next President of the United States. Given that this milestone event occurs once every four years and has significant implications for the economic outlook, it is reasonable to consider the anticipated impact if any on the stock market (NYSEARCA:SPY) from Election Day.

It is worthwhile to reflect on recent history for help in determining what we might expect from stocks following the election. The United States has experienced 16 presidential elections since World War II. The analysis here will focus on these past contests for potential answers.

The first question worth considering is what if anything we might expect on Election Day itself, which falls on Tuesday, November 6 this year. Given that one of the primary risks for the stock market is the political uncertainty associated with the unknown outcome of an election, it is reasonable to evaluate whether the market has shown the past tendency to show any relief from arriving at the day where this uncertainty is about to be eliminated.

In looking back on the last 16 elections, it is worth noting that the stock market was closed on Election Day from 1952 to 1980. As a result, the sample size on Election Day itself is reduced to just eight. And on these eight specific days, the stock market posted an average gain of +0.61%. However, this seemingly solid number is almost exclusively attributed to the stock market performance in on Election Day in 2008, when the stock market rallied by +4.08%. Backing this outlier out of the data set reveals that the market is typically flat on average on Election Day with an average gain of just +0.11% including three up days, three down days and one day essentially unchanged. Thus, investors should expect little from the stock market on Election Day itself.

What about the day immediately after Election Day when the presidential victor is presumably known? In this instance, our sample is reduced to 15 since the final outcome of the 2000 U.S. presidential election remained unknown until mid-December. The average return of the stock market the day after Election Day since World War II over the past 15 qualifying episodes is -0.38%. But just like the sample from Election Day, this result is heavily skewed by the stock market performance the day after Election Day in 2008 when the stock market plunged by -5.27% and gave back all of the advances from the previous day and more. When also excluding 2008 from the data set, the average return for the stock market the day after Election Day is virtually zero at +0.05%. This includes seven up days and seven down days with a standard deviation that is slightly less than the typical stock market trading day.

So despite the fact that stocks generally dislike uncertainty, the market shows virtually no tendency to respond either positively or negatively on Election Day or the day immediately after the outcome of the U.S. presidential election is known.

What about any longer-term effects on stocks? Have completing past elections shown the propensity to give stocks a boost through the remainder of the calendar year? The answer to this question is a definitive yes. The stock market has a track record of generating robust returns through the rest of the year after a presidential election.

In constructing the data set for analysis, the aftermath of the 2000 election is tossed out of the analysis once again due to the lingering uncertainty well into December surrounding the outcome. And the time following the 2008 election must be considered in its own context, as it came in the midst of the outbreak of the financial crisis. While stocks were down over -10% from Election Day through the end of the year, they initially dropped by over -25% through late November before turning sharply and rallying by over +20% through the end of the year. Since these were extraordinary circumstances in 2008, the year is also removed from the analysis.

On first glance, the post election performance of the stock market is impressive. Overall, stocks have generated a +3% return on average from Election Day through the end of the year in the 14 past qualifying events since World War II. This alone is a particularly strong track record. And a number of past election years are prominent standouts in this regard including 1952 (+8.0%), 2004 (+7.2%), 1960 (+5.4%), 1980 (+5.2%), 1976 (+4.2%), 1992 (+3.8%), 1996 (+3.7%) and 1972 (+3.6%).

But when examining the data set more closely, the results in the weeks following recent presidential elections are even more notable.

For example, in only three out of the last 14 election years did the market end the year lower after the election. But in two of these occurrences in 1956 and 1984, the market was essentially flat throughout the entire election season and happened to reach an incremental peak on Election Day in both years. It is also worth noting that both elections occurred during secular bull markets with incumbents who were widely presumed to win reelection throughout much of the campaign. As for the third down instance in 1964, it is worth noting that the stock market first rallied by +1.3% over the first thirteen trading days before trending lower through the remainder of the year.

Also, two other years in particular were marked by extremely strong rallies in the first few weeks following the election that subsequently faded through the remainder of the year. In 1968, stocks posted a robust +5.1% rally in the first 15 trading days following the election, before fading to close out the year at a still positive +0.7%. And although the post election response in 1980 was already ebullient, stocks had actually rallied by an even more robust +8.9% in the first 17 trading days after the election before letting off some steam through the rest of the year.

When adjusting for these intra-period rallies, stocks have advanced by an even more healthy +4.6% on average during the period through the end of the year after presidential elections.

Lastly, it is worth noting in particular the post election performance of the stock market during secular bear market periods (1929-1949, 1968-1982, 2000-Present). When focusing only on those recent past elections that occurred during periods of greater economic uncertainty like today, the average return is an even more robust +5.4%.

Thus, history provides stock investors with reason for optimism in the trading days after the presidential election through the remainder of the year. While the stock market may not react immediately, the precedent exists for a healthy rally over the final weeks of the year, if history is any guide.

Of course, past performance is no guarantee of future results, and it may very well be different this time. While America has indeed faced meaningful challenges in the wake of many past elections, the current financial crisis is unlike anything we have seen since the Great Depression. And the fiscal cliff at the end of the year will remain as a potentially meaningful overhang, particularly if what are likely to be feverish negotiations in Washington after the election prove unproductive and begin to drag on toward the end of the year. Conversely, this year is also unique in that the presidential election is taking place with the U.S. Federal Reserve actively printing money at a rate of $40 billion per month to stimulate the economy and markets. Lastly, while stocks have historically shown indifference as to exactly which political party wins the election, the market may prove more sensitive to this fact in 2012 given the heightened importance of the economy to the electorate this year.

So for those seeking to position for another potentially robust post-election rally in stocks, any such allocations should be undertaken with care and in proportion to other asset classes in a hedged strategy. And stock positions should have a more broadly defined investment thesis that extends beyond just the potential for a post election rally in stocks.

For example, stocks such as BHP Billiton (NYSE:BHP), Occidental Petroleum (NYSE:OXY) and Potash Corporation (POT) have higher beta characteristics that would presumably participate in any post-election bounce but also stand to benefit from the potential asset inflation resulting from the latest round of monetary stimulus from the U.S. Federal Reserve. All three stocks have also underperformed the broader stock market in recent months and are overdue to close this gap.

Selected markets outside of the U.S. such as China (NYSEARCA:FXI) and Brazil (NYSEARCA:EWZ) that possess greater growth potential and scope for additional stimulus that are also beneficiaries of the commodities theme and are already in the process of closing the performance gap with the U.S. stock market may also have appeal. Lastly, allocations to both gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) through the Central GoldTrust (NYSEMKT:GTU) and the Central Fund of Canada (NYSEMKT:CEF) may also be of interest as precious metals that benefit directly from Fed money printing and stand to catch up to the stock market in a year end rally across higher beta investment categories.

Disclosure: I am long FXI, EWZ, BHP, OXY, POT, GTU, CEF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.