With just weeks to go before the upcoming election, many are wondering how the outcome – particularly the presidential election - will affect their investments. In the absence of a crystal ball that can tell you (or anyone) for sure what the markets will do, Mosaic’s perspective is the following:
- Markets and security prices reflect the known information, including the bets that speculators are already making on the outcome of the elections.
- Unless the markets perceive a clear and decisive outcome, markets will likely reflect an increase in volatility in the weeks leading up to the election.
- Investors with very short time horizons should already be holding those funds in cash, and have adequate reserves for short term needs.
- Investors with long term goals should maintain their long term portfolio allocation targets and continue to focus on elements of their financial plan they have control over: spending, saving, and how long and how hard they plan to work.
For those of you who are curious about historical market performance in election years, we believe the commentary and the links below will give you additional insights, and some valuable historical precedent.
If you or others in your professional and social circles have questions, comments, or would like to talk with us about your own situation or circumstances, we welcome the opportunity to continue the conversation.
How will a Clinton or Trump presidency impact my investment portfolio?
Markets generally do not like uncertainty. With that in mind, presidential elections, by their very nature, create uncertainty. Markets have historically been more volatile in election season. In fact, volatility was more significant during an election season at the end of a two-term presidential era, but we’ve only seen a few two-term presidents, so the sample size is a bit small here.
What are your thoughts about the possibility of a significant decline or correction in stock markets?
The market is more likely to rise or fall as a result of world events or changes in the economic outlook than it is to react strongly to the election. Certainly Hilary Clinton is more of a known factor than is Donald Trump, and so as the election nears, if she appears to be in the lead, we believe the market is much less likely to react strongly in either direction than if Trump is leading in the polls. The election itself is typically a market event only if the actual voting is significantly different from the polls and other likely pre-election indicators. In other words, our guess is that there is unlikely to be a big market movement solely as a result of the election results.
What are you going to do for us if the stock market becomes volatile or plummets?
We are long-term investors, and we plan to maintain your globally diversified asset allocation, which is intended to weather volatility on the way to long-term goals. Should we experience a down turn, we’ll make changes as we would normally do to “turn lemons into lemonade” by actively tax loss harvesting in your taxable accounts and by re-balancing when and where appropriate. The first will help by capturing losses and turning them into tax savings. The second helps maintain a consistent risk profile, while buying low and selling high for parts of your portfolio. (For related reading, see Structuring an Investment Portfolio.)
Is this election year going to be good for the stock market?
Well, first it’s worth mentioning that portfolios have performed well in 2016. Despite a scary first seven weeks, US and International equity market indices have shown positive year to date returns through the end of September, ranging from low single digits to mid-teens. How the rest of the year will go is harder to say. We expect more volatility in the markets. But, that’s not necessarily a bad thing (upward trending volatility is something most investors enjoy).
Markets do not like unpredictability as a rule, and as per a recent CNBC article, election years are historically good for stocks, especially so if we exclude the 2008 election when we were in the throes of the Great Recession. US large stocks have gained nearly 10% on average the year before an election, and have produced positive returns 86% of the time during an election year.
Are there election-year patterns?
The standard experience is summer volatility, often including the crest into fall. Then, once candidates and their platforms have been vetted, typically before the election itself, stocks have typically staged a late-year rally, except, of course, for 2008.
Yale Hirsch’s “presidential election cycle theory” asserted that the stock market follows a pattern that corresponds to the election year cycle, but Investopedia notes that the later twentieth century has disproved it. Another pattern floating around is a bit of a reversal: the economy predicting the winner of the presidential election.
Would political gridlock be better for the stock market?
If you aren’t a big fan of change, then having either a split congress or a president of one party and congress of the other party is seen as the way to go. Democrats have been in the White House when markets have performed best (Bill Clinton, FD Roosevelt, and Obama), and struggled more when a Republic resided in the White House (although markets did just fine under Reagan and Eisenhower). Ann Kates Smith reported for Kiplinger that this is currently being dismissed as an urban legend, but added that a divided Congress historically shows healthy returns: “in the two-year periods following the 2010 and 2012 elections, the S&P 500 rose 19% and 42%, respectively.”
What can we expect the stock markets to do post-election?
Within the actual election year, we see a trend that seems to reflect an uncertainty premium before the election and an improvement in that trend after the election, especially if the economy is not in a recession. The US stock market likes certainty. As a result, both large-cap stock returns and small-cap stock returns often improve in the weeks following the election. Also, following the typical election, small-cap stocks have tended to outperform large-cap stocks.
Performance of the US stock market in the first year after a presidential election has generated higher average returns for both large- and small-cap stocks than in the other three years of a presidential cycle (data since 1980). While they may be entertaining, these claims do not provide a sound basis for an investment strategy.
The election will be what it will be, although we certainly encourage you to get involved and help “the good guys” win. The most important thing is to manage your own expectations, and to focus on the things you can control.
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