Investors often look for a causal relationship between presidential election results and stock market performance - but does one really exist?
Elections and the Stock Market - What You Should Know
Last year was a remarkable year in the market and economy, and both are off to a great start in 2020. So what might we expect for the rest of 2020, considering we are in an election year? It seems as though every four years, investors start wringing their hands over the presidential election and the impact it could have on the economy and the markets.
Since the stock market was created, investors have always attempted to find some correlation between election results and stock market performance, asking whether a particular election outcome will impact their portfolios and whether a win by either party warrants a change in their portfolio strategy.
Conversely, investors often muse about the impact of the stock market performance on the outcome of the presidential race. While there seems to be a mountain of data that supports some correlation between elections and stock market performance, it doesn’t conclusively show that the relationship is a causal one that deserves strategic consideration. However, it does make for interesting fodder for the water-cooler crowd.
The Election Prediction Theory
There is no denying that the stock market has a pretty fair record of predicting the results of presidential elections. Since 1900, the performance of the stock market between Labor Day and Election Day has correctly predicted the winner 88 percent of the time. That’s 25 out of 28 elections that the stock market has, in effect, selected our President. That is pretty remarkable on its face, and if you were a betting person, you would have to consider those to be pretty good odds.
There is some logic behind this relationship, the idea being that a rising stock market is a reflection of the general belief by investors that the economy will be stronger in the months ahead. This gives voters a confidence boost, which in turn boosts the chances of a win for the sitting President.
Based on the market’s performance thus far – down 10 percent through March 9 due primarily to coronavirus fears – President Trump may be in trouble come election time. Of course, that could change quite suddenly. The stock market rallied sharply in the six months following the swine flu epidemic in 2009.
The better predictor is actually the state of the economy just before the election. Since 1932, the incumbent has won re-election in 8 of 11 contests. The three losses – Herbert Hoover, Jimmy Carter, and George H.W. Bush – occurred at times when the economy was underperforming. After three years of a strong economy, the prospects for Donald Trump would seem to be fairly positive.
Election Results as a Predictor of Market Performance
The larger issue for investors is the impact of election results on future market performance, and here, the data belies the notion that the stock market should favor Republican policies over those of Democrats. After all, the markets should like free enterprise, lower taxes, and less regulation, right?
Try telling that to George W. Bush. The stock market lost 25 percent during his two terms. Of course, his terms were sandwiched between two recessions and two stock market crashes.
Conversely, the best stock market performance under a two-term President was none other than Bill Clinton, who actually increased taxes. It can be said, though, that the stock market performed extremely well under Ronald Reagan except for two years, the first and seventh, of his eight-year term.
Barack Obama increased taxes and regulations; yet, compared to the five previous Presidents, his first-term saw the biggest four-year return of 46.5 percent. Of course, his first term began just as the stock market hit bottom after the 2008 crash.
The final tally shows that the best stock market performances in the last 30 years have come under Democratic Presidents. Yet, with the exception of Lyndon Johnson who benefited from the tax cuts enacted under John Kennedy, one would be hard-pressed to find a link between Democratic policies and a positive performance in the stock market.
The final analysis: As impressive as the correlations are, there is zero evidence of any causal relationship between elections and stock market performance. It’s possible to parse any set of data to have it conform to the predilection of any theory. That’s why investors have an equally fair chance of predicting market performance when they use the Super Bowl indicator (an NFC-team win portends a positive year for the market), which has an 80-percent success rate.
As those who follow the fundamental principles of investing know, the markets are random, and they do work efficiently regardless of who is in office. Principled and disciplined long-term investors don’t invest for an election cycle, they invest for a lifetime. Vote your conscience and keep your eye on your target.
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