No matter your political preferences, this election is likely to be a memorable one. On Tuesday our nation’s future will be decided after months and months of campaigning. Will Hillary Clinton or Donald Trump be our next president?
The results of this election will have far-reaching consequences, from healthcare to immigration. Many investors are wondering, though, what the consequences will be for the stock market.
Historical Election Year Market Trends (1)
Looking back at history, it is fascinating to see how closely related market cycles and presidential terms are. For the 60 years from April 1942 to October 2002, there were 15 stock market cycles, each about four years long. Not coincidentally, presidential terms are also 4 years long.
Diving deeper, bear markets historically occur during the first and second years of presidential terms, while bull markets occur during the third and fourth years. Election years are the fourth of the presidential term. In fact, a bear market defined as a decline in the S&P 500 Index of 15% or more over a period of 1-3 years never occurred during an election year from 1942-2002.
What Causes The Cycles?
Why is there such a direct correlation between political and economic cycles? The simple answer is fiscal policy. The Federal Reserve has gotten a lot of attention as of late for their ability to impact the economy through setting interest rates and controlling the money supply. The executive branch of the government also has their own means of influencing the economy, mainly through taxation and spending.
It isn’t any wonder that politicians have discovered a correlation between the health of the economy and voter satisfaction. Because of this, as an election approaches, those in power do what they can to boost the economy in order to keep their party in power through the next election. The exercise of fiscal policy to strengthen the economy leading up to an election contributes to election year bull markets.
Once the election is over, the new party in power gets down to business and economic appearances are set aside. All the hype and optimism surrounding a candidate’s promises also fades away as they get into office and the realities of governing set in. This is why the first two years of a presidential term are typically slower times in the markets. Later, as the presidential term passes the two year mark, fiscal policy picks up and carries the markets up until the next election. And so the four-year cycle continues, keeping step with the presidential election cycle.
What To Expect This Year
Most anyone who has been following the election at all would be quick to tell you that this is not a normal election. This year’s political race has been anything but ordinary, to say the least. On the extremes, some people are going so far as to predict complete economic collapse depending on which candidate enters the white house. But does it really matter as much as most people think?
Looking back to 1900, the data shows that, at least where your portfolio is concerned, it doesn’t make much of a difference which party wins the election (2). The below chart shows the S&P 500 under both Democratic and Republican presidents.
So, history tells us that we should expect moderately positive market returns this year which will slow down once the new president takes office. Because of the unprecedented and often unpredictable nature of the 2016 race, investors should be prepared for short-term volatility as well.
What You Should Do
Whether it’s an election year or not, equity markets can help investors grow their assets, but investing is a long-term endeavor. Trying to make investment decisions based upon the outcome of presidential elections is unlikely to result in reliable excess returns. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. You are better off relying on patience and portfolio structure, than trying to outguess the market, in order to pursue investment returns.
If you are unsure as to the durability of your investment strategy, it is important to get a second opinion from an experienced professional. Also, if the high emotions and sensational media coverage of the 2016 election are getting to you, sitting down with an expert advisor can help calm your fears and keep you from making irrational investment decisions.
Over a 25-year career in financial services, Rick has helped hundreds of business and personal clients meet their investment goals by developing risk-efficient portfolio management strategies. He holds degrees in Economics and Psychology from the University of California, Irvine.
The water is Rick's second home: He and his family have been fishing Southern California and Baja going on four generations. In the 1940s, his grandmother worked at the Cannery Restaurant in Newport Beach—when it was an actual Albacore cannery. In the 1950s, his father was on the crew that built two of the boats still in service at Dana Wharf Sportfishing.
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