Do Presidential Elections Affect Stock Market Returns?
By Bryan Lee, CFP®, MBA
Financial markets prefer predictability. However, every four years, the political landscape becomes uncertain, bringing with it a wave of anticipation and speculation that reverberates throughout the financial markets. Indeed, the connection between presidential elections and stock market returns is a topic of perennial interest, with investors eagerly seeking insights into how political outcomes might shape their portfolios.
The relationship between presidential elections and stock market returns is complex and multifaceted, influenced by a myriad of factors ranging from policy proposals and economic indicators to investor sentiment and geopolitical dynamics. While predicting the precise impact of an election on stock prices is impossible, historical data and academic research offer valuable insights into the patterns and trends that have characterized this relationship over time.
One common perception is that the stock market tends to perform better under certain political parties. Historically, Republican administrations have often been associated with pro-business policies, such as tax cuts and deregulation, which are perceived as favorable for corporate profitability and stock market performance. Conversely, Democratic administrations have prioritized addressing social issues and wealth concentration, which may have different implications for various sectors of the economy.
However, the reality is far more nuanced. Studies examining stock market returns during different presidential terms have yielded mixed results, suggesting that a multitude of factors beyond political affiliation influence market outcomes. For instance, the state of the economy, current and upcoming tax policy changes, global events, and the Federal Reserve's monetary policy can all exert significant influence on stock prices, sometimes overshadowing the impact of political leadership and Congress’s fiscal policy.
Source: Dimensional
The Federal Reserve (more commonly known as the Fed) is an independent agency from the federal government that provides the nation with financial stability and flexibility. In addition to supervising banks and other financial institutions, the Federal Reserve oversees monetary policy, which can involve governing interest rates (among other things) to achieve macroeconomic policy objectives, such as hitting certain targets for unemployment levels and inflation rates.
Although the Fed is an independent agency, the President appoints the seven members of the Board of Governors. Their terms are meant to be staggered and can last up to 14 years to maintain independence from the Oval Office. Of these seven members, the President also nominates the chair and vice-chair for the Federal Reserve. The President’s appointees work to fulfill the President’s goals for national employment, price stability, and financial stability.
Beyond the influence of the executive branch and the Fed, the actions of Congress also impact the economy through tax policy, regulation, allocating government expenditures, trade policy, and social policy such as healthcare, education, Social Security, and other legislation. History indicates that regardless of the party in power, the stock market has generated significant financial returns for long-term investors:
Source: Dimensional
When comparing stock market performance under various political regimes, it becomes clear that a balance of power is generally correlated with positive stock market performance. Because markets respond well to stability, checks and balances in the executive and legislative branches may be one factor in providing investors with desirable financial returns:
Moreover, the relationship between elections and stock market returns can vary depending on the timeframe considered. In the immediate aftermath of an election, markets may experience heightened volatility as investors react to the uncertainty surrounding policy changes and the potential implications for corporate earnings. This volatility can persist until clarity emerges regarding the new administration's agenda and its ability to implement proposed policies.
However, historical data also indicates that markets have generally exhibited resilience over the long term, regardless of the election outcome. While short-term fluctuations may occur, driven by sentiment and speculation, the underlying fundamentals of the economy and corporate performance ultimately dictate the trajectory of stock prices over time and the political outcome is mainly just noise. Investors who maintain a long-term perspective and focus on investing in a broadly diversified, low-cost portfolio rather than allowing short-term political events to influence their investing decisions are more likely to achieve sustainable returns.
Additionally, it's essential to recognize that not all sectors of the stock market respond uniformly to presidential elections. Certain industries may benefit from specific policy initiatives, while others may face headwinds. For example, infrastructure spending plans could boost construction and industrial stocks, while healthcare reforms might impact pharmaceutical and healthcare companies differently.
In conclusion, while presidential elections undoubtedly command attention from investors, the relationship between electoral outcomes and stock market returns is complex and multifaceted. While certain trends and patterns may emerge, attempting to time the market based solely on political developments is fraught with uncertainty. Instead, investors are wise to focus on diversification, reducing investment costs, and keeping a long-term perspective to navigate the ever-changing landscape of politics and finance. Time in the market rather than the attempt at timing of the market is always key. Ultimately, it's the resilience and adaptability of the market that prevails, transcending the ebb and flow of political cycles.