Sep 2, 2020 Election Season v. The Stock Market

Election season can be a challenging time for investors to maintain a long-term perspective, given the strong emotions often evoked by politics. Campaign rhetoric tends to amplify negative and divisive issues. In particular, this election is unprecedented in modern times — marked by the combination of a deadly pandemic, a severe economic recession, widespread civil unrest, and extreme market volatility.

We would caution investors against making short-term changes to a long-term plan to try to profit or avoid losses from changes in the political winds. Our views on government don’t always translate to the way we view our investment portfolios.

How do Presidential elections affect my portfolio?

The answer – based on decades of historical data – is that presidential elections typically don’t have a long-term effect on market performance. The first half of elections years tend to be more volatile when political uncertainty during primary season is high. Markets have managed to power through during the second half of election years regardless of whether a Democrat or Republican won the White House.

Using an allocation of 60% equities and 40% fixed income, Vanguard found a modest return differential under administrations of different parties. They also found that a fair return differential exists between presidential election years and non-election years[i].

In the four-year presidential cycle, the third year (pre-election year) has tended to be the strongest for stocks, as sitting presidents have taken measures to boost the economy and stock market higher to garner votes.

Returns in election years have been quite strong as well. Stocks have had negative returns in only two of the last 20 election years (2000, 2008), and both declines were primarily attributed to asset price bubbles rather than politics. The first half of election years tend to be weak, followed by a second-half rally. On average, they have returned 6.7% and have been up 82% of the years since 1950 (see chart)[ii].

Furthermore, when a president has been up for reelection, it has tended to boost stocks. 1940 was the last time the S&P 500 was lower during an election year with an incumbent in the White House[iii].

The chart below shows the S&P 500 up an impressive 11.7% on average if the President was running for reelection, compared to up an average of 2.4% if President was a “lame-duck president.” A lame-duck happens with the sitting President either isn’t running for reelection or has already fulfilled the maximum two terms[iv].

Many may want to credit or blame the President for stock market performance, but the truth is that their policies have little impact on stock market returns. Financial markets are incredibly complex systems affected by many different variables. Earnings, valuations, the health of corporate balance sheets, the level of interest rates, and the economy are some of the more critical influences on market behavior.

In this election, the stakes are particularly high for corporate America. If Democrats regain the Senate as well as the presidency, there is an increased risk for more regulations and taxes. Importantly, it may lead to an increase in the corporate tax rate from 21% to 28%, reversing half of Trump’s tax cut.

A 28% tax rate would cut the S&P 500 after-tax earnings by 12.7%, all else being equal. Companies have paid far less than the stated rate for years. The effective rate fell 6.6% points from 2017 to 2019. Reversing half of the 2017-19 effective tax rate decline would trim earnings by 4.2%[v].

The makeup of Congress is important

Regardless of which party wins the presidency, investors should remember that Congress will likely act to muffle the impact of either President’s proposals. Congress has often proven to be a useful buffer between the President’s aspirations and the economy.

Since 1950, stocks have tended to do their best when we have a split Congress (see graph)[vi]. Markets tend to like checks and balances to make sure one party doesn’t have too much sway.

Can market data tell us who will win?

History shows that the US economy has had significant bearings on the presidential election outcomes. If a recession occurred during the year or two before the election, the incumbent President has tended to lose. If there were no recessions during that time, the incumbent typically won. Incredibly, the economy has predicted the winning President every year going back to the 1920s.

In addition to the economy, the stock market has had some predictive power. Since 1928, the stock market has accurately predicted the winner of the presidential election 87% of the time, including every single election since 1984. It’s quite simple. When the S&P 500 has been higher the three months before the election, the incumbent party usually has won; when stocks were lower, the incumbent party usually has lost.[vii]

While this data is interesting and good trivia knowledge, the stock market is massively complex, and teasing out causation is incredibly tricky. We have only a small number of observations to look back on (there have only been 19 presidential elections since 1950), and many different factors besides politics influence stock returns.

On the other hand, looking at the numbers, the candidates’ height may matter more than their party[viii].

We might also want to look at which hand the candidates write with – left-handed presidents had better stock market returns. The average annual market return during the tenure of a left-handed president was 17.4%. While on the “other hand,” the average yearly return when there was a right-handed president was 11.6%[ix].

Or we could look at the last Washington Football Team’s home game before the election. When the Football Team wins, the party of the incumbent President retains the presidency; when the Football Team lost, the opposition party wins. This was true in every election from 1940-2000. Unfortunately, it has been wrong in three out of the last four elections.

Now, how tall the President is or which hand they write with probably doesn’t make a difference, but it’s a good lesson in the limits of statistics. Statistics can only describe what happened. They say nothing about causation. When we find a relationship, it’s up to us to look at it and decide if the connection is meaningful – is this cause and effect or mere happenstance?

Figuring out which relationships are meaningful is one of the biggest challenges in finance. It’s easy to find relationships that aren’t there. Given an hour with the data, anyone could discover five new statistically significant relationships connecting things like a football team’s win to a presidential winner, but that doesn’t mean one is a result of the other.

Ultimately, an investment strategy based on the outcome of elections is unlikely to gain any reliable edge. At best, any positive effect based on such an approach will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, to pursue investment returns.

Conclusion

Equity markets can help investors grow their assets, and we believe investing is a long-term endeavor. If you are worried about a particular party winning, it is essential to remember that we don’t invest in presidents or governments, but corporations. Our system of divided government helps ensure that no one leader consolidates all power. Regardless of who wins, short-term developments are less critical to your investment success than the big picture trends that will shape markets in the years ahead. So while we will be paying attention to the news, we will also continue to make sure that your portfolio is well-diversified, that your investment costs are kept low and that you are on your best path forward.

Footnotes:

[i]. Vanguard calculations of a 60% equity, 40% fixed income portfolio are based on data from Global Financial Data. Years are categorized based on which political party occupied the White House for the majority of the year.

[ii] LPL Research

[iii] LPL Research

[iv] Factset, LPL Research. 1/17/20

[v] Ned Davis Research

[vi] Bloomberg, LPL Research. Data from 1950-2019

[vii] Factset, LPL Research. Data from 1928-2019

[viii] McLean Asset Management. Data from 1926-2015

[ix] McLean Asset Management. Data from 1926-2015

 

Disclosures:

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Past performance is no guarantee of future results. Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any particular strategy or investment will prove profitable.   As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. This newsletter should not be regarded as a complete analysis of the subjects discussed.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.

For additional information about LRIA, including fees and services, send for our disclosure statement as set forth on Form ADV using our contact information herein. Please read the disclosure statement carefully before you invest or send money.

 

INDEX DEFINITON

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

 

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Important Disclosures

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein and take no responsibility therefore.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.