Presidential Elections and Your Investments
Talk about the 2016 presidential election is at a fever pitch. The first presidential debate in September was the most watched in American history, and with all the social media coverage, it’s a wonder the internet hasn’t broken!
With the candidates and the issues as polarizing as they are, it’s natural to feel some anxiety about the future. And specifically the future of your investments. There’s no shortage of opinions about how a win by either candidate will affect the economy and the investment markets. And it doesn’t help when you hear emotional comments such as: “If (Insert name here) wins, the investment markets are doomed!”
So what should you expect from your portfolio during the election cycle?
Fundamentals first, politics second
Politically, our nation has become much more polarized and partisan in recent years. As we wrangle over social and economic issues, emotions can run high, and can override rational decisions.
Investment markets are considered, “rational”, and focus on fundamentals like inflation, economic growth, corporate earnings, etc. However, the participants in investment markets are just people after all, and in the short run can be spooked by surprises they hadn’t considered or situations they thought were unlikely.
The sharp reactions to the United Kingdom’s vote to leave the European Union (BREXIT) is a classic example of a negative surprise. But investors soon looked past the surprise, re-evaluated the economics and the likely impacts on company earnings, and adjusted their expectations accordingly. The result was that after a few days of volatility, markets quickly recovered. Investors who sold in panic were left behind.
The lesson here is to focus on the economic fundamentals. While the recovery since the 2008 financial crisis hasn’t been particularly inspiring, the U.S. has led the rest of the developed world in terms of economic growth, corporate profits, bank lending, etc. Nationally, employment is almost back to pre-crisis levels, though clearly there is still room for improvement. Inflation has been a big concern, but hasn’t really shown up in the data so far. Company profits have set new records, as have the prices for stock market indexes like the S&P 500. These are the factors that will drive stock prices higher (or lower), and right now, the fundamentals look fairly solid.
Election time: a good or bad time to invest?
Plenty of studies have been done on elections and market returns. Patterns can be seen in some of these studies that favor investing in certain years of the presidential election cycle. It’s human nature to try and spot patterns and act on them. For instance, volatility is usually high leading up to an election, but there have been only three election years in the last 21 where the S&P 500 index had a negative return. This may lead an investor to try and leverage the pattern, perhaps selling investments at some point and then buying back in. However, those three negative years were really bad negative years (2008 was one of them), and so trying to game the system brings a whole lot of risk for a really limited benefit. Better to have a balanced, diversified long term strategy and stick with it throughout the cycle.
Which candidate is better for the investment markets?
Predictions about presidential elections and the stock market often focus on which party or candidate will be “better for the market” over the long run. The below chart from Dimensional Fund Advisors shows the growth of one dollar invested in the S&P 500 Index over nine decades and 15 presidencies (from Coolidge to Obama). As you can see, there is no obvious pattern of long-term stock market performance based upon which party holds the Oval Office. The key takeaway here is that over the long run, the market has provided substantial returns regardless of who controlled the executive branch.
Investing is a long term endeavor
Equity markets can help investors grow their assets, but investing is a long-term endeavor. Trying to make investment decisions based upon the outcome of presidential elections is unlikely to result in enough excess return to justify the risk.
This is not to downplay the importance of the Presidential election. There are aspects of the Presidency which can and will have an impact on the country. There will be a steady stream of opinions from pundits and prognosticators about how the election will impact the stock market. It’s best to avoid the temptation to make significant changes to a long‑term investment plan based upon these sorts of predictions.
One thing we know for sure is that emotion is an unreliable tool for investing. A far more reliable strategy is to base your decisions on a long term strategy, and ride out the day-to-day volatility. And, periodically rebalance to take advantage of other’s emotional reactions.