The candidates for both parties have nearly been set and the final drive to our presidential election is about to take place. Investors have had a nervous start to the year, starting with a sell-off of about 10% and then a quick recovery. As each party is vying for the position, it is not uncommon to hear on the news about how different managers are offering several different strategies to combat the volatility in the market.
Most media outlets start with a chart much like the one below. As you can see, it looks like on average, having a Democrat in office has yielded consistently positive returns regardless of what type of congress they have. The Republicans, on the other hand, have the highest returns when they control congress as well, but also actually average negative returns if they hold the presidency but have to contend with a split Congress. The conclusion might be as long as a Democrat wins the election, returns should be positive in the equity market. But if the Republicans win, keeping an eye on congress becomes incredibly important to know how to invest.
However, this is where both the media and statistics can get you into trouble. While all of the above numbers are completely accurate, that does not mean they are relevant at all. Before declaring any type of correlation, you must have enough data points in order for the information to be significant. A simple example of this might be a six-sided die. If you roll it just 10 times and you roll a “5” 4-times, you might come to the false conclusion that your chances of rolling a “5” are 40%. The problem is that with so few rolls, there really isn’t enough data to actually draw an analysis. The same is true of presidential elections. In reality, there really hasn’t been that many, especially when you think of the modern economy only stretching back about 80 years, meaning there have only been about 20 elections total during that time.
In the next chart, we pull the data to try and figure out how relevant a presidential election year is to how the market performs by using a regression model. This measurement will give a rating between 0 and 1 with 0 meaning no correlation and 1 representing a perfect correlation. As you can see in the chart, none of the data sets are even close to representing any type of correlation.
Does this mean that the presidential election is irrelevant to the stock market? No, the economic policy of the winner can impact how the markets move. However one should be very careful in using an investment strategy that looks at imperfect historical data to build a portfolio. At Cedarstone, we believe in building a solid financial plan that reflects your goals and assets and that you should choose a strategy that is robust enough to meet those goals regardless of who our next president it.