How Does the Stock Market Behave Around Elections?
Will the U.S. Election Affect Stock Market Returns?
With both the Democratic and Republican National Conventions wrapping up and candidates formally accepting their parties’ nominations, more and more attention is turned toward Tuesday, November 3.
While there is much debate about which candidate will prevail, there is also no shortage of theories about what a Trump or a Biden victory could mean for the stock market. The historical data show that capturing the long-term returns of the capital markets does not depend on which party controls the White House.
We’ve Been Here Before
This debate isn't unique to the 2020 US presidential election; similar questions arise every four years and, sometimes, the election results coincide with large market moves. Many will recall that futures markets had the S&P 500 index down more than 5% the evening of the 2016 election, only to finish in positive territory the day after the election.
As investors are constantly bombarded by headlines about the latest polls and a suggested policy or tax reform, it's easy for them to take all this uncertainty, boil it down to a single event like an election, and worry about what it could mean for their portfolios.
Maybe it would be safer to just sit on the sidelines and let it all pass? In the words of the famous football coach and sports commentator Lee Corso – “Not so fast, my friend.”
How Does the Stock Market Behave Around Elections?
Going back to 1928 when Herbert Hoover defeated Al Smith (444-87 in the electoral college), we have data for 23 presidential elections through 2016. This isn't a very large sample size, but we aren't trying to get too precise with our analysis, so bear with us. We looked at returns in the three months leading up to the month of the election (August through October), and both the three months and six months after the month of the election (December through February and December through May) for all 23 elections. Figure 1 illustrates the results.
What do we find? On average, returns are positive in all three periods for the 23 election years but returns vary widely. For example, the average return for the six-month period following the election month is about 7.5%, but the range goes as far as about -14% to more than +56%.
Figure 1 | Stock Market Returns Have Varied Widely Around Elections
CRSP U.S. Total Market Index Returns Before and After U.S. Presidential Elections (%)
In Figure 2, we show the same data but with the winner of each election and his party (red for Republican and blue for Democrat). Continuing to focus on the six-month period following the election month, returns were higher following Democrats’ victories (11.1% vs 3.5% for Republicans). They were also higher for challengers over incumbents (9.4% vs 5.4%).
Does this mean a Biden victory is likely to lead to better returns over the next six months? No. From what we see, there is no statistical evidence that could point to that.
Let's zero in on one former Commander-in-Chief to put this into context. Franklin Delano Roosevelt (FDR) was victorious four times, first in 1932. The average return for the six-month period following his victories was 15.8%.
But again, averages don't tell the whole story. For example, if we take out the period following his first victory, which includes the spring of 1933 - a period often pointed to as the beginning of the recovery from the Great Depression - that average falls to just 2.3%.
Why is this important? Those four elections had a lot in common - the same individual, same party, etc. - but vastly different results following each election. This reinforces the importance of looking beyond the election.
The Big Picture
While policy decisions and the regulatory environment no doubt have an impact on the economy and the markets, these are only a few among a long list of factors. Market expectations associated with election outcomes are embedded in security prices. Investors are individually and collectively assigning probabilities on these and other inputs as they agree to buy and sell securities in the market, building expectations about the future into market prices.
What's the takeaway for investors? While the election will dominate headlines over the next couple of months, don't worry about its impact on stock market returns. Regardless of your expectations about the outcome, step back and think about the bigger picture. If you work with Gap Financial Services, you have a long-term financial plan that has been designed with the uncertainty around these sorts of events in mind.
Figure 1 & Figure 2 Data from 7/31/1928-5/31/2017. Source: Ken French’s Data Library. *CRSP U.S. Total Market Index: Comprised of nearly 4,000 stocks across mega, large, small and micro capitalizations, representing nearly 100% of the U.S. investable equity market.
DISCLOSURES: This information is primarily sourced from Avantis Investors for educational purposes only and is not intended as investment advice or tax advice. Please consult your financial advisor or tax advisor for more detailed information or for advice regarding your individual situation. The opinions expressed are those of the portfolio team and are no guarantee of the future performance of any Avantis fund or ETF. References to specific indices are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Past performance is no guarantee of future results.