Investing in the stock market during an election year

You’ve probably noticed the Presidential election is dominating the news lately. Trump or Biden, Biden or Trump. Defund the police, COVID-19, you can’t escape it! It’s fairly obnoxious. Election year investing may seem stressful, but the reality is it isn’t any different than any other year

Unsurprisingly, there’s also been an upsurge in political discussion amongst investors. Voters who support Biden think the galaxy will implode if Trump is re-elected. Those who support Trump think the planet will explode if Biden is elected. I certainly hope neither is right!

Neither our galaxy nor our planet will be destroyed. It doesn’t matter who wins the election.

What you’re likely more worried about is the economic effects either candidate will attempt to bring about. Remember, the President alone cannot simply impose their will. We have a system of government that requires the approval of the House and Senate. Getting anything done at all requires a great deal of compromise (assuming neither party runs the entire show).

I thought it would be fun to look at bond and stock market results throughout the history of election cycles.

How does the stock market do in election years?

As you can tell from this graph—and as you may expect—the results both pre and post-election years are pretty positive throughout history.

The S&P 500 averaged an 11.3% return in election years going back to 1928. The year after the election the S&P 500 has averaged a 9.9% return. Since the S&P 500 has averaged about 10% throughout the same period this probably doesn’t surprise you too terribly much.

Most investors are looking for some sign of what the markets will do if either party wins the election. I can’t find any real pattern in this chart, however. Can you?

What stands out to me is the year after the election has had more negative results than the year of the election. Out of 23 “year after the election” periods, the stock market actually had negative returns 10 times.

Putting that into perspective, the stock market lost only 4 out of 23 periods during election years. What does that say about the stock market and post-election year investing? One possible conclusion is the stock market is more likely to perform poorly the year after an election year.

Contrast that with the upside returns in post-election years. The years post-election which were positive had substantially higher returns than the average election year. A second conclusion, therefore, is post-election years exhibit substantially more volatility. They’ve illustrated negative returns more than twice as often as the election year, yet also enjoyed substantially higher positive years.

The bond market during election years

Bonds are far less volatile than stocks. They promise the repayment of principal and interest over time. Stocks promise nothing, on the other hand, they’re far more volatile.

You may be wondering how bonds performed during the election and post-election years. The bond market has very little correlation to the stock market after all. Let’s take a look at the results:

As you may have guessed bonds in general have very few bad years. Keep in mind these are not inflation-adjusted returns. After accounting for inflation, bonds have many negative years to account for.

Post-election years have shown a great deal of volatility for stocks. In theory, this may equate to stronger performance for bonds since they’re fairly non-correlative to stocks. This theory plays out in the chart above.

Bond returns in election years are 7.6%. Subsequent to election years bonds returned 7.3%. The difference is negligible as you can see from the graph.

Can any conclusions be drawn about the bond market during election cycles? Not really. Bonds acted like they generally would in any other year.

What can we expect this election year?

Nothing more or less than any other year. Elections are irrelevant in large part.

Hoover had the Great Depression to deal with, as did Roosevelt. Bush had 9/11 to deal with and a real estate/mortgage market implosion. Outside of that, every other Presidential term has been dynamically positive for both the bond and stock market on average.

Are you focusing on the wrong thing?

Every investor says they’re a “long term” investor (every wise investor anyway). The problem is emotionally we’re not wired to be “long term” investors. Just by being human, we’re subject to many cognitive biases, and election-year investing behavior isn’t any different. 

What really matters to you and your retirement plan? Is it the short term volatility that the stock market brings every year? Maybe it’s the minuscule returns your bonds pay?

Is it really the election you should be worrying about? Perhaps you’re focused on the wrong thing. In 19 of 23 Presidential terms, the stock market finished resoundingly positive!

In every single Presidential term bonds have finished positive as well:

So what the heck are we moaning about? You’re a short term investor – or you’re smart. When it comes to your investments, you’re politically agnostic – or you’re not. Don’t let your political biases mess up your retirement plan! This election is every bit as irrelevant to the stock market as I told you the Brexit vote was!

I’m sure this will generate a reaction, but I believe it or I wouldn’t say it. The election is irrelevant to your investment portfolio in large part. Our system of government prevents anyone elected official from acting irrationally (though I’m sure some will debate this).

If you want to argue the virtues of fiscal or economic policy over long periods of time, I’m game. This one election however isn’t going to change your investment results no matter who wins.

Democrats do better with the stock market

OUCH! I said it. I’m not trying to stoke any battles, I’m just stating the facts. Those facts seem diametrically opposed to common wisdom, however.

Common wisdom says that Republicans are “business-friendly”. Because of this, the stock market should do better under Republicans. That’s what we’re told anyway. The fact is the stock market has performed better under a Democratic President.

Don’t take it from me, however. Alan S. Blinder and Mark W. Watson – both Princeton economists – researched stock market performance during election cycles. Their paper “Presidents and the U.S. Economy: An Econometric Exploration” analyzed 64 years beginning with President Harry Truman and ending with President Obama.

And the results are in

The analysis verified the stock market performs better under a Democratic President than it does under a Republican President. But why? They cited the following:

• Gross Domestic Product. GDP growth averaged 4.35% under a Democratic President and 2.54% under a Republican President.
• Unemployment. Under Democrats, unemployment was 5.64% versus 6.01% under Republicans.
• Income. While the gap is not significant, real wages grew slightly faster under a Democratic President.
• Recessions. The National Bureau of Economic Research classified 49 quarters out of the 256 quarter sample size as a recession. Republicans controlled the White House 41 of those 49 quarters.
• Inflation. There was little difference in inflation between either party’s control of the White House.

These factors all lead to stock market performance. A study finds what you’d expect based on the strength of the factors noted. The stock market performed better under a Democratic President. The S&P 500 returned 9.7% under Democratic control and 6.7% under Republican control.

But does the outperformance have anything to do with Democratic policy?

The authors of the paper went on to say Democrats should not take credit for the exceptional performance under their control. Rather than take credit for fiscal or monetary policy driving the stock market, other factors out of their control have more to do with it.

Oil price volatility (or lack thereof), wartime defense spending, and varying productivity levels have more to do with stock market growth than Democratic policy. The authors stated:

Some, maybe all, of these might be considered blends of good policy and good luck. But our empirical analysis does not attribute any of the partisan growth gap to fiscal or monetary policy.

Let me play devil’s advocate for a moment…

The stock market returns are convincingly better during a Democratic-controlled Presidency. Numbers are what they are. You can’t manipulate real-life results.

But as the Princeton authors noted it’s not necessarily fiscal or monetary policy that drove those results. Aspects the President doesn’t directly control drive the stock market in large part.

What if you’re convinced that fiscal and/or monetary policy really was the determining factor in the stock market’s performance?

If you’re convinced fiscal or monetary policy is the cause for the exceptional stock market growth why would you give credit to a Democratic-controlled White House? Fiscal and monetary policy changes very slowly. You can’t just snap your fingers and feel the effects of tightening the money supply or lowering taxes.

Why can’t you credit the Democrats?

Actual economic effects take many months up to multiple years to really be felt in the economy. It also takes months to years to get anything passed in Washington before it’s enacted.

Since it takes so long for these changes to materialize – then have an impact the economy – couldn’t one argue the Democratic Presidential terms are simply enjoying the economic effects of a Republican Presidential term? Is that a stretch?

While it’s quite possibly a stretch, I’m just playing devil’s advocate. I don’t think stock market performance during any election cycle is directly attributed to who wins the Presidency.

Undoubtedly Congress and the President have some effect on the economy, and hence the stock market’s performance. There are many more factors outside of governmental control that affect the stock market over time.

The economy naturally ebbs and flows. Wars come and go. Current events change for better and for worse. Some companies innovate and soar, others flounder and die. Many critical factors outside of the government drive long term economic growth, and hence stock market performance.

Investing in the stock market during an election year summarized

So what have we learned?

• Economic results are stronger under a Democratic President
• The stock market is stronger under a Democratic President
• The stock market performs better than average in an election year
• Post-election year investing has been much more volatile in a post-election year
• Bonds have performed fairly consistently regardless of elections over time
• The universe will not implode no matter who wins the election!

The performance of any given asset class is quite random year over year. You simply cannot predict it, just like you can’t predict the outcome of the election nor the stock markets reaction to it.

Going back to my point “are you focused on the right thing”. It’s important to remember you’re a long term investor. Over the long term average returns for both bonds and stocks are pretty positive no matter who’s running for – or wins – the Presidency.

Rather than focus on the election this year, focus on the important things. Your financial plan should be your #1 priority. Look closely at your asset allocation and make sure it fits with your financial plan. Use strategies to reduce your taxes as much as possible. Make sure your loved ones are protected if something happens to you.

Finally, put a microscope on your savings and spending patterns. Miscalculating your budget is the single biggest killer of any otherwise successful retirement plan.

Some things matter and some things you can control. Very few things which matter you can control when you find them they’re golden! If you’re going to concern yourself with anything, make sure it’s something you can actually control that matters! There are far more important things for you to waste time thinking about the election.