This year has been a crazy time for the economy and the stock market. While dealing with the onset of a global pandemic, we have an upcoming presidential election to add fuel to the fire. I’d say “uncertainty” is the word of the year.
Our actions during these stressful and emotional times can have a major impact on our well-being after the election and COVID have passed. I say this because people tend to make decisions based on emotions in the short term, which can negatively impact them in the long term. In this article, I will explain research that has been published by Dimensional Fund Advisors to provide some insights into the stock market and the US presidential election.
Stock Market Performance During Presidential Election Years
I will be referencing this slide deck titled “Market Returns During US Elections” throughout this article. On the first slide there are three statements made that are an overarching theme to this research. These statements are:
“It is difficult to identify systematic return patterns in election years.”
“On average, market returns have been positive both in election years and the subsequent year.”
“Market expectations associated with election outcomes are embedded in security prices.”
These comments sum up stock market returns and expectations in general, regardless if we are talking about a presidential election or the state of the economy. It is extremely difficult to find patterns that persist and predict what is going to happen. The market is a future-looking mechanism and reacts very quickly to new public information. Current prices are a product of new information and are based on the future expected returns, or cash flows or appreciation, for companies.
Prices reflect the outcome of the election already. Roughly 50% of people think Trump will win and 50% of people think Biden will win. We have some information about fiscal and tax policy from each candidate, so prices are already taking this information into consideration. People tend to think one winner is going to impact the market significantly once they win, but the reality is this is already reflected in the market prices to a certain extent.
Example 1 shows returns of the S&P 500 during and after U.S. election years. When you look at the S&P 500 during election years, on average it has returned 11.3%. The year following a presidential election it has returned an average of 9.9%. This data is going back to 1928 through 2017.
Annualized Stock Market Performance During Presidential Terms
Example 2 shows the annualized returns during U.S. presidential terms. The average return for the S&P 500 when looking at presidential terms is 10.3% from 1929 to 2019. This is showing returns in 4-year increments. If you look at the ratio of negative vs. positive return rates for all the terms, 17.39% of the time the S&P 500 has been negative.
This means that 17.39% of the time the market has been down for the length of a presidential term. Stated another way, the market has shown a positive return 82.60% of the time.
These figures coincide when looking at annual returns year over year in the fact that the majority of the time there has been positive returns. On average, the total U.S. market is positive 74% of the time, or negative 26% of the time.
Performance of Emerging Markets During the US Presidential Election
If you look at the historical data of international developed and emerging markets you will see similar results. The MSCI EAFE index from 1972 to 2017 shows the average return during an election year is 6%, and afterwards the returns are on average 14.5%.
The annualized returns during U.S. presidential terms from 1973 to 2019 have been 8.9%. This equates to 25% of the time presidential terms have been negative, while 75% of the time presidential terms have been positive.
We have similar results in emerging markets, albeit a little more extreme, which is to be expected since you are dealing with economies and companies that are less established and come with more risk. Going back from 1988 to 2017 the average returns of the MSCI emerging markets index during a U.S. election year has been 3.8%. The average return the year after an election has been a whopping 34.4%.
The annualized returns during U.S. presidential terms for the MSCI emerging markets index from 1989 to 2019 has been 10.4%. This data shows that emerging markets have been down 25% of the time, and positive 75% of the time, which is consistent with other markets.
We like to see consistency across different markets. This typically means that the data is sound and not an anomaly. It is statistically significant.
What Does This Election Mean for Investors?
Investors put their money in the stock market because they expect a greater return than say bonds or cash. That said, there is no free lunch in the sense that greater returns are guaranteed. Anything can happen day to day, or year to year, but over the long haul we expect a greater result in comparison to other asset classes. This is the relationship between risk and return.
Long term stock market data has shown to reward investors who stay invested in the market over multiple decades. You have a much greater chance of success staying the course than trying to time the market based on a presidential election or economic policy changes. This can also help with stress levels if you adhere to this philosophy and outlook.
Have faith in the markets and focus on what you can control.
If you’d like an objective second opinion about your finances, please contact Michael Shea, a CERTIFIED FINANCIAL PLANNER™ at Applied Capital. Email him at [email protected] or fill out a contact form.
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