The stock market has a knack for proving investors wrong and this year is no exception. How, many of our clients have asked, can the market continue to advance in the face of such extreme electoral turmoil? The thinking here is not entirely off-base. Presidents wield tremendous influence over the fiscal and regulatory policies that affect corporate profits, a key driver of stock price returns.
Political commentators on both sides of the aisle are claiming solid rationales for the market’s recent favorable performance. Democrats point to better chances for a more robust stimulus bill and a return to more consistent domestic and international policies. Republicans highlight their party’s positive gains in Congress and resulting ability to temper more extreme Democratic policy proposals going forward. The reality, of course, is likely to be far more complicated. Public policies on everything from the environment to taxes and spending do matter to a company’s ability to innovate and thrive, but their impact can take years to play out. And while politics matter, at any given point in time who sits in the White House may not be the most important factor driving results. Consider Exxon Mobil. Regulatory policy under the Trump administration has been quite favorable to the energy industry. But so far this year Exxon is down 43%. While a more supportive regulatory environment has helped, it has done little to offset the recent collapse in global energy demand related to the pandemic.
Longer term, the link between electoral outcomes and stock market returns is far from clear. Typically, investors have considered Republican administrations favoring limited regulations and lower taxes good for stocks. Divided governments too have generally been favored by investors – when neither Democrats nor Republicans receive broad electoral support, the status quo rather than extreme policy changes are likely. As the chart above shows, however, historical results throw both assumptions into doubt. Over the past 91 years, the S&P 500 produced the highest average annual returns when a Democratic President sat in the White House (either with a split Congress or not). The benefit of divided government, which is the most common scenario historically and the current expected outcome, looks a little more compelling. While studies vary, most conclude that stocks produce equal or better returns under a split government versus when either party holds full control of both the White House and Congress.
It is important to remember that the relationship between election results and stock returns described above is tenuous at best. While 91 years seems like a long time, it is most likely insufficient to draw firm cause-and-effect conclusions. And importantly, because this study examines average returns, it masks a lot of underlying variability. Every election cycle is different.
Despite this, investors continue to try and “game” election results. The rationale here is similar to that which drives most short-term trading behavior. Often, investors respond to periods of extreme uncertainty by trying to see (and exploit) short-term patterns that simply do not exist. Attempting to jump in and out of stocks has long been proven to be an unprofitable strategy. A better approach is to assess the amount of risk (i.e., volatility) you are comfortable with and then, as they say, go sit quietly in a room. The big conclusion from the chart above should not be what party produced the best market returns. Rather, it is that stocks gained ground in 59 of the 91 years (65% of the time) and that the average return over the entire period exceeded 9%.