Fun Facts on The Election & The Stock Market…and Why None of Them Matter

Crosby_2015Dr. Daniel Crosby, Executive Director, The Center for Outcomes & Founder, Nocturne Capital

With less than one month remaining until the election, the already frenzied political coverage is sure to become even more fevered in the coming days. While each presidential election is unpredictable, it seems certain that this one is destined for the history books. For all of their sophistication, are there any political pundits that correctly predicted the rise of Bernie Sanders or that Donald Trump would emerge from a pack of 16 more politically experienced Republicans?

Adding to the confusion is that recent popular votes of all stripes—from Brexit to the Colombian peace deal—have not gone the way pollsters predicted. In the face of all of this uncertainty it is natural to wonder, “could the U.S. be the next surprise?” And a natural follow-on question is, “What does all of this mean for my money?” To begin to answer these questions, let’s look at some historical trends around U.S. elections and the stock market.

Incumbent vs. Challenger

Most considerations of political impact examine how potential candidates might influence the market, but let’s begin our study by flipping that on its head and ask, “How might the market help determine who wins the election?” As you might expect, incumbent parties are helped enormously by a rising market and challengers tend to be swept into power by a poor market.

washington_wallstreetSince 1928, 14 of the 22 presidential elections saw a rise in the broad market in the three months leading up to the big vote. In all but two of those instances, the incumbent party stayed in their comfy digs on Pennsylvania Avenue. But what of the eight instances where the market was down in the run up to the election? All but one of those more bearish periods saw the incumbent ousted from power.

This phenomenon was seen most recently in the failed reelection campaigns of George H.W. Bush (1992) and Jimmy Carter (1980). Bill Clinton, sensing the natural tendency of hard economic times to bring about change chided the senior Bush with his now famous “It’s the economy, stupid” line. The date to watch for this particular metric in this election cycle is August 1, at which time the S&P 500 closed at 2,170.84.

Democrats versus Republicans

Inasmuch as Republicans are broadly perceived as the more pro-business of the two parties, it may come as a surprise that the stock market has performed considerably better under Democratic than Republican presidents. In fact, since 1945 the average annual gain under a Democratic president is 9.7%, easily besting the average gain of 6.7% on the Republican’s watch.

But a closer look at the statistics tells a more nuanced story as, to borrow a Dickensian turn of phrase, Republicans have presided over both the best of times and the worst of times. The market’s most successful run occurred under Republican Gerald Ford—a whopping 18.6% annualized. However, the elephants also own the only two losing records in modern (post-1945) market history, with George W. Bush (-4.6% annualized) and Richard Nixon (-5.1% annualized) both overseeing periods of extended bearishness.

electionThe Election Cycle

Having now examined the market’s ability to predict the winner of the election and the impact of parties on performance, let’s look at the influence of the presidential cycle on market returns.

Since 1833, the market has typically produced the best returns in the year preceding an election, averaging 10.4% annualized. Election years themselves have tended to be good as well, with average returns at right around 6%. The worst years in the election cycle have been the first and second years of a president’s term, averaging 2.5% and 4.2% respectively. The conventional logic has been that familiarity breeds comfort and that the uncertainty surrounding the economic policies of a new leader have driven low returns early in the cycle.

Why None of This Matters

Having gone to some pain to research the relationship between the election and the market, let me now suggest that none of what you have read above matters. None of it. Our desire to look for signal in the unending noise surrounding political campaigns is a waste of time at best and can be dangerous to our financial well-being at worst. The government produces data on 45,000 pieces of economic each year and when they are laid on top of the mountain of data collected by political scientists, correlations emerge and most of them are spurious. To quote political pollster Nate Silver, “The temptation that some economists succumb to is to put all this data into a blender and claim that the resulting gruel is haute cuisine.” To make this point more concretely, consider some of the following:

  • Since 1928, election years like this one without an incumbent running for reelection have been some of the worst on record, clocking a -2.8% annualized return. Had you been aware of and acted on this information, you would missed the 5.37% gain for the large cap index year to date.
  • As discussed above, the market tends to gain 6% in election years. Great, but small comfort to those who lost 34% in 2008, an election year. It has been joked that a six-foot man can easily drown in a river that is three feet deep on average (since many parts of the river might be much deeper). The same can certainly be said of market returns where long-term averages tend to mask the more dramatic volatility underneath. The performance of the market is more attributable to economic conditions than superior policies. Democratic Presidents Roosevelt and Obama both inherited markets broken by the Great Depression and Great Recession respectively. While both deserve credit for guiding the nation during difficult times, they are also the beneficiaries of a tendency for stock prices to mean-revert and bounce back from dramatic lows. Bulls and bears may have less to do with donkeys and elephants than the statistics might suggest.
  • Finally, consider the research suggesting that the first year of a President’s term leads to the most paltry returns. Had you acted on this knowledge, you would have missed the 23.45% rise in the market in Obama’s first year in office and the double-digit advance in the first year of Bill Clinton’s presidency. By definition, averages are generalities that are not true of any specific situation and relying on them can cause deviation from an otherwise sound financial plan.

Election years introduce volatility and uncertainty into financial markets that leave investors and advisors alike searching for a calm port in a wild political storm. But in our efforts to make sense of the political and economic landscape, we run a real risk of finding connections where none exist. In 2016, one of America’s most powerful political dynasties was nearly upended by an independent and self-proclaimed democratic socialist. The Republican Party is now helmed by a reality television star who has never held office. The Cubs are in the playoffs.

At uncertain times like this, investors must return to what Jason Zweig refers to as “controlling the controllable.” The outcome of the election and the accompanying market reaction are very much unknowable. What remains very much in your control are your ability to diversify across multiple asset classes, maintain a long-term focus and work closely with a competent advisor to manage your own behavior. I don’t know who will win the White House and neither do you, but I know with some certainty that patient investors adhering to first principles will always come out ahead.

Sources:

http://www.kiplinger.com/article/investing/T043-C008-S003-how-presidential-elections-affect-the-stock-market.html

https://tickertape.tdameritrade.com/investing/2016/08/can-election-predict-market-performance-10313

https://www.ml.com/articles/how-presidential-elections-affect-the-markets.html

http://money.cnn.com/2015/10/28/investing/stock-market-democrats-republicans/index.html

http://www.comstocksmag.com/article/data-driven-0

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

World Cup of Liquidity

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

With the eyes of the world currently trained on Brazil, and the incredible spectacle of the globe’s most popular sporting event, there is another coordinated effort taking place on the world stage, albeit one with less fanfare and pageantry, but possessing a far greater effect on the global economy, and that is the historically accommodative policies of two of the world’s major central banks. The unprecedented amount of liquidity being thrust into the system by these institutions has helped fuel the current bull market in equities, which continues to push stocks listed around the world further and further into record territory.

World CupThe more powerful of these central banks, the Federal Reserve Bank of The United States, is attempting to gradually extricate itself from a portion of the record measures it has taken to revive growth following the Great Recession, which have caused its balance sheet swell to more than $4 trillion (New York Times) while not causing the economy to suddenly decelerate. “To this end, last week the Fed announced a continuation of the reduction of its monthly bond purchases by $10 billion, bringing the new total to $35 billion.” They also voiced their collective intention to keep short-term interest rates at their current historically low levels until 2015. Financial markets rallied following this news as investors focused largely on the Fed’s comments regarding rates, as well as the little-discussed fact that although their monthly purchases are being slowly phased out, the Central Bank continues to reinvest the proceeds from maturing bonds, thus maintaining a measure of the palliative effect. According to the New York Times, “Fed officials generally argue that the effect of bond buying on the economy is determined by the Fed’s total holdings, not its monthly purchases. In this view, reinvestment would preserve the effect of the stimulus campaign.” Although the American Central Bank is attempting to pare back its efforts to boost growth in the world’s largest economy, the accommodative measures currently in place look to remain so long after its bond purchases are concluded.

Preisser_Liquidity_6.23.17_2Mario Draghi, on June 5, made history when he announced that the European Central Bank (ECB) had become the first major Central Bank to introduce a negative deposit rate. As part of a collection of measures designed to spur growth and combat what has become dangerously low inflation within the Monetary Union, the ECB effectively began penalizing banks for any attempt to keep high levels of cash stored with them. In addition to this unprecedented step, Mr. Draghi unveiled a plan to issue four-year loans at current interest rates to banks, with the stipulation that the funds in turn be lent to businesses within the Eurozone, (New York Times). The actions of the ECB were cheered by investors who sent stocks listed across the Continent to levels unseen in more than six-and-a-half years, with the expectation that the Central Bank will remain committed to combating the significant economic challenges that remain for this collection of sovereign nations. To this end, Mr. Draghi suggested, during his press conference, that he is considering additional growth inducing measures, which may include the highly controversial step of direct asset purchases. Mr. Draghi gave voice to his resolve, and a glimpse of what the future might hold when he said, “we think this is a significant package. Are we finished? The answer is no” (New York Times).

The actions of both the Federal Reserve and the European Central Bank have directly contributed to the current rally in risk assets, but have also created a conundrum of sorts for investors; as though their historic measures have sent prices to record levels, the conclusion of these programs carry with them serious risks of disruption, as they too are unprecedented.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.