How Do Election Years Impact the Stock Market?
Since the economy makes up a significant portion of U.S. policy and politics, it’s understandable that investors would get jumpy during election years. Will the stock market crash if so-and-so presidential candidate is elected? Or will it reap big gains for investors’ portfolios?
Looking at the historical pattern, we can see that presidential election years have tended to correlate with stock market gains. But as with everything related to the market, past performance is no guarantee of future results. We caution anyone against changing their investment strategy simply because it is an election year.
Read on for an analysis of potential connections between election cycles and market performance, and what they can mean for your portfolio this year.
How the Market Has Performed Historically in Election Years
In the year running up to a presidential election, history has shown that the market is more likely to do well. Only four election years between 1928 and 2016 showed negative returns in the stock market. The other 19 election years had gains.
Source: Dana Anspach, “Stock Market Performance in Presidential Election Years,” The Balance, updated Sept. 2, 2020.
The four election years that experienced down markets all had fairly obvious explanations that weren’t election-related:
In 1932, the U.S. was fighting to recover from the Great Depression.
In 1940, World War II was imminent.
In 2000, the tech bubble burst.
In 2008, the U.S. suffered a financial crisis and plunged into the Great Recession.
Performance of the Stock Market after Elections
The cyclical market pattern seems to extend beyond the election year. According to a Schwab Center for Financial Research study, the three years following a presidential election have shown average annual returns of 5.8%, 4.5%, and 13.7%, respectively.
Historically, it appears that the first two years of a president’s term have tended to be less impressive when it came to market gains, while the third calendar year after an election seemed to be the strongest. Year four (election year) historically took second place, at 7.1%.
Yale Hirsch, the creator of the Stock Trader’s Almanac, called this phenomenon the “Presidential Election Cycle Theory.”
Do Politics Affect the Market, or Vice Versa?
So it can seem like a fair assumption that politics and the economy are tightly related. But should we assume that the market is driven by political machinations—or is it actually the reverse?
Any economist will tell you that market performance has many influencers, such as:
Interest rates
Corporate profits
Investor confidence and expectations
Business cycles
Trade policy
Inflation and deflation
Gross domestic product (GDP)
Globalization
Unpredictable world events, like this year’s COVID-19 pandemic
So, with all these factors, separating political specifics from other influences becomes difficult, if not impossible. While it’s interesting to look at trends over time, we don’t advise that you use these patterns to determine your investments.
Our Greenwood Village, CO financial planning firm works with clients to develop and implement a long-term investment strategy based on factors such as their age, risk preferences, financial situation, and goals. Consider creating a similar strategy, perhaps with the help of a financial advisor, and then stick to it even in election years when you may be anxious (or eager) about election results.
Perhaps a more useful way to view a potential correlation between politics and markets is to consider the reverse: The state of the market appears to influence election outcomes with more regularity.
Since 1928, when the market saw gains in the three months leading up to an election, the incumbent party won the White House 12 out of 14 times. When the market was seeing losses in the three months leading up to the election, the incumbent party lost seven out of eight times.
You Can’t Beat the Market
So how are investors supposed to react to the relationship between the market and presidential election cycles?
You may decide to follow any number of one-size-fits-all strategies out there that advise you to invest on a certain date of a presidential term and sell by another date. But if you had followed the advice of one of these versions during either Barack Obama’s or Donald Trump’s presidential terms, you would have lost money.
There are clear patterns relating to presidential terms and market performance—but again, in the end, past performance cannot guarantee future results. And it’s generally more likely that markets affect the election, not the other way around.
Your best bet is to ignore presidential elections when it comes to your financial decisions. As always, you’ll do best with long-term planning and a diversified portfolio structured to help you reach your personal financial goals, no matter who wins the presidency this November.
Discuss your situation with a fee-only financial advisor. Schedule a complimentary discovery call.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
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