You may have heard that another presidential election is coming up soon. For many investors, this one feels more consequential than most, and the advisers at Vickery have been fielding more election-related questions from clients than usual this time around. It is certainly true that this election could bring significant changes on the policy front, including tax policy. But can anything be said about the potential impact on financial markets? As evidence-based investors, we’ve studied the data and it turns out the answer is “surprisingly little”. Let’s examine why this is the case-
(1) It is important to note that if we review stock market performance and GDP growth for all 4-year presidential terms during the entire post-WWII period, there are only 18 observations in total. This is an exceptionally tiny dataset and makes the task of drawing statistically significant conclusions difficult. We should take the findings of any study with a large grain of salt.
(2) Markets have generally done well under Republican and Democratic administrations. One reason for this is that both parties want strong economic growth and a booming stock market, even if they differ on the right policy prescriptions to get there. Remember – corporations are typically run by shrewd, profit-maximizing capitalists. Historically, they have been excellent at adapting to whatever kind of economic and political environment they find themselves in.
(3) The market effectively incorporates new information into security prices very quickly. In most cases, markets have a pretty good sense of election outcomes before they happen. Trump’s election in 2016 may have been an exception, but even in that case, there was no surefire way to profit from the result. As the realization of Trump’s surprising victory became clear on election night, world markets initially became very volatile, falling by 5% at one point, but nearly all of the turmoil occurred overnight in the relatively illiquid futures market. By the end of the next trading day, the S&P 500 index had recovered all of its overnight losses and ended up 1.1% from the day before. The speed of the market moves was breathtaking, and only the luckiest and most nimble of traders could have profited from such volatility. After Trump’s inauguration, the US stock market continued climbing at a healthy pace, just as it had done over Obama’s eight years in office.
(4) Monetary policy may be more important to market performance than fiscal policy. The composition of the Federal Reserve won’t change on January 21, 2021 and neither should their current policy. Chairman Powell’s term does not expire until February of 2022.
(5) There is a great deal of luck involved, both good and bad, during any four-year presidential term. A president may govern during an oil shock, a pandemic, a technology boom or the end of the cold war. Much of what will happen over the next four years will simply be out of their control.
With those caveats in mind, what does the data tell us about how the economy and the stock market fare under Democratic vs. Republican administrations? In a November 2013 paper titled “Presidents and the Economy: A Forensic Investigation”, Princeton economists Alan Blinder and Mark Watson attempt to answer this question with a thorough analysis. On the economy, they find that the Democrats come out notably ahead, with real annual GDP growing 1.8% faster on average than under Republican presidents. Corporate profit growth and total nonfarm employment have also done better under Democrats historically. However, the authors attribute this result largely to “good luck” as the Democrat’s macroeconomic policy prescriptions were not significantly different than those put forth by Republicans. As further evidence for their hypothesis, the authors point out that Republican administrations have been particularly unlucky when it comes to negative oil shocks, and have endured unexpected spikes in oil prices that slowed economic growth during their terms.
The Democrats also appear to have the edge on the stock market performance. Since 1948, the average annual return on the S&P 500 has been 5.4% higher when a Democrat resides in the White House. The difference sounds quite large at first glance, but due to the high volatility of stock market returns and the low number of total observations, the figure was not statistically significant. Also – much of this performance differential can be attributed to just two events — a deep bear market during Richard Nixon’s second term (1973-74), and the Global Financial Crisis during George W. Bush’s second term (2007-08).
While the conclusions of this study are intriguing, the most important takeaway is markets tend to go up regardless of who occupies the White House. That fact alone informs our conclusion that “sitting out” the markets is simply not a viable strategy for investors, no matter their political beliefs. Instead, we should remain focused on long-term outcomes, and trust that corporations will continue delivering value to their shareholders.