It’s another election season, and for investors that means another year of trying to figure out what impact politics will have on the financial markets. Few investors disagree on the fact that there is a direct effect, but as with everything that relates to politics, there is much debate on what that effect will be. Politicians, especially at the national level, have the scary ability to make policy decisions that could decide the future of entire industries.
Election Terms and the Market
One of the most interesting numbers to look at is average returns for the S&P 500 during a president’s four-year term. In the first term we typically see the smallest gains, averaging 3.4%. This climbs to 4.0% in their second year, then spikes to 11.3% the third, and finally settles at 9.5% during the next election year.
The most likely explanation for this is that most presidents are either planning on running for re-election, or on their second term they are trying to set up another win for their party in the next presidential election. This mindset makes them push through all of the potentially damaging legislation that needs to happen in the first two years of their term. This can come in the form of taxes, regulation, trade agreements, or other important policies that have a negative effect on the economy. They then can keep a focus on economic improvements during their last two years.
This year’s election takes place near the end of one of the longest bull markets in history. Combine that with the average dismal numbers on a president’s first term, and it may be time to start reallocating your 401(k).
Another way the elections influence the markets is based on which political party takes the office. Most people labor under the belief that the stock market does better when Republicans win the presidency. This would make sense because Republicans are generally considered the more pro-business party, but it is actually completely false.
Looking closely at average yearly gains since the depression, markets have increased 9.7% under Democrats versus 6.7% under Republicans.
While this is a fairly large difference, there is no evidence to say that this is actually due to policies. With over half of the S&P 500 profits coming from outside the U.S., it is more than likely due to the world economic climate.
If there is one thing investors hate, it’s uncertainty. People make money on the stock market by finding patterns in a variety of things. They use these patterns to predict stock prices in the short or long term. Uncertainty tends to break patterns and make predicting much more difficult.
For this reason, stocks tend to be volatile in the months heading up to a presidential election. Many investors have their finger on the sell trigger, and are quick to sell into any news that could affect their assets negatively. This causes abrupt drops in the markets as stop losses kick in and supply overpowers demand.
This year is a great example of investor’s political fears. Donald Trump represents an unknown that investors do not know how to deal with. As an outsider, Trump leaves investors uncertain about what kinds of policies and reforms he will enact. This uncertainty makes investors nervous.
Similarly, a lot of investors also expressed fear about Bernie Sanders, who has since dropped out of the race. Sanders, also an outsider, ran for office on a platform that promised to hit Wall Street hard, particularly big banks. Had Sanders won the election, it would almost certainly have sent banking stocks into a dive in preparation for new regulations and policies.
Statistics Aren’t Everything
It is incredibly important to remember that statistics aren’t everything. Many of these numbers are averages taken over a long period of time. The markets have broken these norms many times, and will likely break them many times in the future. Don’t make all of your investment decisions based on statistics like these, but bear them in mind as the choices are made.