How will the election impact the market? If Biden wins will the market crash? What about a Trump win? Will the uncertainty alone but enough to derail the recovery in the economy and the markets? Economic data appears to confirm a very strong recovery in the 3rd quarter of 2020, now the biggest questions on everyone’s mind appear to be about politics. This week we will review market behavior during election years and what this data means for investors.
Despite the many articles on the subject, history does not teach us much about the behavior of the market in the months leading up to the election. From August to October of every election since 1928 the market was indeed down on average, but this data point does little to guide us. First, there are only 23 election years since 1928, a sample size too small to generate much confidence. Of the 23 elections, 13 had gains averaging 4%, and 10 had losses averaging 6.2%. 2008 stands out with a 24% decline leading up to the election, and does much to sway the average, but it is hardly a predictor of what is in store for this year.
The S&P 500 performance during Democratic versus Republican administrations is also a weak analysis. We again have the problem of very few data points. The 6 Democrat administrations over 48 years returned average annual gains of 10.5%, and the 7 Republican administrations over 39 years returned 6.9%. But what are we to gain from this analysis? There are many more variables, more critical variables, impacting stock prices. Politicians like to place blame and take credit for economic performance, but the truth is that presidents likely had very little to do with the performance of the stock market.
What history can teach us is that through a myriad of trials, and through innumerable law changes, companies do figure out how to make money. It is important to remember that corporate earnings drive stock prices. It is that creative ingenuity that we tie our investments to, not the political winds of one party or another. In the face of political uncertainty, I for one, take some comfort in this fact.
History also teaches us that presidents do not have total control. The president is not a king, and it is rare for one party to have the House, Senate and Presidency. As a result, Washington is known for its gridlock, a characteristic frustrating to politicians, but often welcomed by markets. Markets love stability, the byproduct of gridlock. America’s founders were geniuses, parsing power so that it would be difficult for one person or party to rule by fiat. This is an important lesson for those too focused on the presidential election. If the Republicans keep the Senate, which is likely, and the Democrats keep the House, which is likely, then either president will be hampered in his ability to make changes without compromise.
In the face of uncertainty, it is important to review your long-term strategy. There will always be unexpected events, including political or policy changes that the market does not anticipate. The best approach is to be appropriately defensive up-front so that your future does not depend on guessing the future correctly. Said another way, if you believe that your investment portfolio is at risk if the wrong person is elected, then it may be time to look at the risk in your investment portfolio.
Over the coming weeks we will be analyzing the policies of each candidate, and the potential tax and investment implications for each. As we do so, it is important to remember that political outcomes are incredibly difficult to predict, and not the only factor in an investment strategy. The business cycle is very powerful force and economic data points to an incredibly strong recovery in the 3rd quarter. No matter who wins the election, the ultimate winner may just be the economy itself.