Election Day is not far away…How do presidential elections affect the stock market?

How do presidential elections affect the stock market?

With the U.S. presidential election just a few weeks out, coupled with the unprecedented media coverage this election has garnered, many people are questioning how the upcoming presidential election might affect their investment portfolios. They are also asking if they should be making some investment changes to perhaps protect their investments due to the somewhat antagonistic nature of this year’s presidential campaign.

The fact is that economists have extensively researched the effects that a presidential election has had on the stock market in the past going back for more than a century. One widely known theory (at least to investment professionals) is aptly called the “Presidential Election Cycle Theory” which was developed by stock market historian, author and theorist Yale Hirsch. This theory postulates a slowdown in financial market trends in the first year following the election. We’ll dive into this theory a bit later. Before doing that, we think the first question that needs to be addressed is what has actually happened in the past to the U.S. stock market “during” the year of the presidential election.

Presidential election years are typically positive for the U.S. stock market.

Based on research provided by InvesTech Research, history shows that in seven of the last nine presidential election years, the S&P 500 index ended the year higher than where it started. Going back further all the way to 1928, sixteen of the past twenty-two election years have been positive for the S&P 500 index. Of course, this also indicates that stocks declined in six election years. However, two of those declining years were in 2000, when the dot com bubble burst, and 2008, when the Financial Crisis hit, which suggests the declines in those years probably occurred for reasons more than the upcoming presidential election.

Importantly, most of the stock market gains made in presidential election years occurred in the second half of the year. Given the good performance of U.S. stocks during third quarter of this year, it appears that so far, 2016 stock market performance is consistent with this second half thesis.

What happens to U.S. stocks in the years after the presidential election is surprising.

Over the past 100 years or so, theorists and researchers have pointed out that when a Democrat is in the White House, stocks tend to perform slightly better than when a Republican is in office. This is surprising to think about since conventional wisdom alleges that Republicans are more “business-friendly” than Democrats. However looking back more than a century to the early 1900’s, the Dow has returned almost 9% annually when a Democrat is in the White House compared to around 6% when a Republican is in office. That being said, it is interesting to note that in Barron’s recent Big Money Poll, 60% of big money managers think Clinton, a Democrat, will be the next President. So this could be good news for 2017. While this is certainly a thought-provoking observation, we believe the question of which of the parties is moving in to 1600 Pennsylvania Avenue shouldn’t be your sole focus in making your investment decisions.

Another fascinating notion suggests that markets tend to flourish when Congress is split between parties. The theory behind this is that when the government is divided, neither party can fully implement their most drastic agendas which allow the markets to bloom unfettered. Interestingly, this theory isn’t born out of history according to researchers at InvesTech who have analyzed equity returns dating back to 1928 under three dissimilar circumstances. Accordingly, in the 2 years following an election, the S&P 500 stock index has gained 16.9% on average when the same party controls the White House and both houses of Congress; 15.6% when one party is in the White House and the other party controls Congress; and just 5.5% when the House and Senate are split. It is significant to note that a congressional divide doesn’t always seem to result in sub-optimal results. In the 2 year periods following the elections in 2008 and 2012, the S&P 500 climbed around 19% and 42% respectively. However it is critical to realize this most current cycle has been anything but average, so no one can be certain as to what the next cycle will bring.

The Presidential Election Cycle Theory

The “Presidential Election Cycle Theory” developed by Yale Hirsch asserts that U.S. stocks are weakest in the first year following the election of a new U.S. President and then steadily improve until the next presidential election cycle. While this isn’t a hard-and-fast rule, it is an interesting perspective based on the idea that the uncertainty of the actions of a new President could result in market volatility leading to returns moving in a sideways fashion during the first 2 years. Moreover, Hirsch suggests that returns are generally strongest during the third year of the presidency at which time the markets are able to digest political and economic strategies as rationally as possible.

While this theory was somewhat reliable in the early to mid-1900s, more recent data has disproved it. For instance, in George H. W. Bush’s first year, the market was up +25.2%, and Bill Clinton’s first year saw the market gaining +19.9%. On the flip side, inside of being up as theorized, the U.S. stock market was down during the third year of Bush’s second term due to the 2008 Financial Crisis.

OK, so much for “theories” which may be more appropriately call “myths” in at least some cases. Suffice it to say, big political events like the upcoming presidential election can cause a lot of concern. Regardless of how incredible the correlation between election cycles and financial markets appear, this alone should not drive your risk tolerance or investment decision making process. It’s important to recognize that you have portfolios built around your risk tolerance and long term goals.

If you would like to talk more about any of the topics discussed above and if or how they affect your CAMP portfolio, please feel free to give us a call.

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