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Presidential Elections and the Stock Market

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Every four years, Americans get a chance to vote for a new president. While outcomes are often uncertain and results can prove unsettling, the reaction of financial markets over time has proven to be fairly unremarkable, perhaps even rather staid.

That might seem a little counterintuitive. After all, in the days leading up to Donald Trump's surprise win in 2016, many pundits cautioned that stocks were poised to take a steep fall if such a political neophyte moved into the White House. For example, Citigroup issued a forecast prior to the election that predicted markets would suffer an immediate 3-5% drop if he assumed office. In fact, major U.S. stock indexes climbed to then-record highs following his victory. 

In the months and weeks before a presidential election, markets often get overheated. Stock volatility can soar as headlines blurt out the latest poll numbers and cable news analysts scramble to make sense of it all. In such a politically charged environment, it's easy for investors to get confused by stocks moving in a different direction than they expected.

This often leads investors to abandon their current investment strategies. Instead, they too frequently favor reallocating portfolio assets based on the belief that markets will move in a certain direction as a result of a predicted election outcome. As discussed in the video below by Kenneth French, a finance professor at Dartmouth College and a nationally recognized authority on the behavior of security prices, any form of market timing is an exercise in futility.

Investors can find solace in the fact that markets are forward-looking, meaning that current prices are a reflection of the expectations held by buyers as well as sellers. Roughly 10 million traders participate daily in the real-time interplay that defines free markets by establishing a structure for agreement on a fair price.

By its very nature, such a dynamic and equitable pricing process is designed to take into account all news and publicly available information to market participants. As a result, expectations of future market changes can be found embedded in a share's price. 

Our own research and the work of leading academics have found no definitive correlation between election outcomes and any stock market movements. A case in point: The bar chart below shows stock market results during presidential election years and the following 12 months. It compares average annualized returns of the S&P 500 Index going back to the presidential election year of 1928. 

The large-cap index returned an average annual 11.28% during these calendar election years. At the same time, the S&P 500 had an average annual gain of 9.88% in the calendar year following a presidential election. 

Only one discernible pattern emerged over this timeframe, which involved 23 different presidential elections: the S&P 500 was positive a vast majority of the time. (See chart below).

In most cases, U.S. presidents left office with the benchmark higher than when their administrations took over. (See chart below.) Exceptions included the sequential terms of Calvin Coolidge and Herbert Hoover, both of which were engulfed by the Great Depression. Also, the 43rd president of the United States (George W. Bush) finished his term mired in the early days of the 2008-2009 Great Recession.

If this isn't enough evidence of the folly in trying to time markets based on election cycles, consider the chart below. From 1926 through 2019, the longest period of S&P 500 data available to us, the index's average annual return for years in which Republicans controlled the White House and both chambers of Congress was 14.52%.

That was exactly the same return that resulted when Democrats held unified power in Washington, D.C., over this period. 

What about stock market results in those years when the U.S. had a divided government? As shown in the graph below, returns of the S&P 500 Index generally kept rising whether Democrats or Republicans held power on Capitol Hill.

The big picture takeaway is striking: Trying to outguess other market participants based on a presidential election isn't likely to be a very logical or reliable way to make informed asset-allocation decisions about a globally diversified and passively managed stock portfolio. Along these lines, we present below a video by Dimensional Fund Advisors focused on similar election-related investment issues.) 

While putting money into index funds is our recommended way to build wealth, IFA's advisors stress that investing is a long-term undertaking. The best-case scenario of betting on election outcomes is that any oversized return will likely be the result of random luck. At the same time, letting emotions guide the investment process can lead to costly mistakes.

Instead of relying on political prognostications, we urge investors who are concerned about future elections to focus on ensuring that their portfolio risk exposures match their risk capacity. Along these lines, a comprehensive financial plan can be a powerful tool to assist investors in the accomplishment of their investment goals. Such a holistic-minded plan, which takes into account portfolio holdings along with other assets making up a household's total balance sheet, is available to all IFA clients on a complimentary basis.

This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Investing involves risks, including possible loss of principal. This is intended to be informational in nature and should not be construed as tax advice. IFA Taxes is a division of Index Fund Advisors, Inc. For more information about Index Fund Advisors, Inc., please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.