Stock market data from election years may challenge widely-held expectations from investors.
The yard signs are up, campaign ads are playing before online videos, and political bumper stickers are decorating cars. For those living in the U.S., the upcoming presidential election is hard to ignore.
Many investors are also taking notice, anticipating big swings in the stock market regardless of who wins the election. But much like the rest of the events of 2020 so far, the exact nature of those market movements is hard to predict.
While there is no detailed blueprint for how the fourth quarter will turn out, investors can use historical data to make more informed decisions.
VOLATILE CAMPAIGN TRAILS, TEPID MARKETS
The markets tend to reflect anxiety about the unknown, and the outcome of a presidential election is hard to predict with even the most shoo-in candidate. Investors are unsure what to expect, whether the country elects a new candidate or the incumbent has a chance to introduce ambitious second-term policies.
Conventional wisdom would suggest that this heightened apprehension of political uncertainty would mean the markets are usually volatile during election years. However, according to data collected from Macrotrends, the CBOE VIX Volatility Index shows the average closing price of election years are considered in the “normal” range.
Analysts consider a VIX level below 12 to be “low” and a level above 20 to be “high,” making the range between them considered “normal.” Considering the U.S. presidential election years going back to the early 90s, most years have an average closing price of about 15.
There are two election years during this period that had VIX volatility levels in the “high” range. However, these outliers arguably had other factors that affected the stock market: the tech bubble in 2000 and the recession in 2008.
HIGH OR LOW TURNOUT?
As oppressive as a divisive political season may seem, chances are the stock market may be more optimistic. Since 1928, the S&P 500 Index has ended on a positive note in 17 of the past 23 presidential election years. That’s about 74 percent of the time, with an average annual return of 7.1 percent.
On the other hand, the two calendar years after the presidential elections tend to be less positive. This trend prompted Yale Hirsch, founder of the Stock Trader’s Almanac series, to develop the Presidential Election Cycle Theory. The theory suggests the U.S. stock markets are predictably weakest in the year following the election of a new president, though modern analysts do not consider this a hard-and-fast rule.
Some investors associate stock market performance with the political party that wins the election; specifically, many believe a Republican win tends to lead to better market performance due to the party’s usual pro-business stance.
In actuality, there is not a dramatic difference between political affiliations in terms of market performance. If anything, Democrats have a slight edge; when a Democrat has been in the White House, the average return for the Dow Jones Industrial Average has been around 8.5 percent since 1900, whereas the average is around 6 percent for Republicans.
THE WHOLE PICTURE
As with most trends in the stock market, we can apply the phrase “correlation does not imply causation” to the election cycle. There are several factors that affect the markets, from the (mostly) predictable — such as business cycles and corporate profits — to the unpredictable (namely, a certain 2020 pandemic). The results of the federal election are just one component of the market’s performance in the fourth quarter.
Analyzing individual sectors may be more useful when investigating the relationship between the stock market and the election. For example, a spring 2020 review from the University of New Hampshire found a noticeable impact on healthcare stocks during election years, suggesting the policies in election campaigns and an increase in media coverage draw attention to the sector.
Among the presidential election years that coincided with markets that underperformed, most of them had reasons for a lower performance besides the federal election. For example, in 1932, the Great Recession was on investors’ minds, and World War II dominated attention in 1940.
And of course, there may be other issues in 2020 that are on investors’ minds besides the election. In a stressful year that has so far included lockdown measures during COVID-19, natural disasters, and racially-charged social issues, the economy has had to contend with unusual circumstances and may continue to do so for the next few months.
MORE THAN A TWO-HORSE RACE
Making investment decisions based solely on data patterns is problematic for several reasons. For one, market indicators always leave a certain amount of risk. Just because the market has mostly behaved a certain way during past election years does not mean it is guaranteed to perform the same way this year.
Secondly, historical data may be limited in their scope. Although these numbers can be informative for understanding the broader socio-economic ideas, they don’t always reflect the current climate. The most important factors that contributed to market performance in the 1920s, for example, may not be as relevant to 2020.
Looking at the history of the stock market can be an helpful resource for investment decisions, but studying current market conditions, diversifying your portfolio, and developing your personal investment strategy may give you a more comprehensive approach.
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