October, 2022
KEY POINTS
- It’s difficult to identify any election year systematic market return patterns.
- Market returns on average have been positive the year following mid-term elections.
- Market expectations associated with elections are embedded in current prices.
It’s almost Election Day in the U.S. As we know, every two years the full U.S. House of Representatives and one-third of the Senate are up for reelection. While election outcomes are uncertain, we can be certain to expect plenty of opinions and prognostications in the media.
In the financial media, any topic perceived having an impact on the market and stock prices will be covered ad nauseum. The Wall Street Journal recently published, “After Punishing Year for Stocks, Investors Aren’t Betting on Post-Midterm Rally” speculating whether an 80-year record won’t happen again in 2022 — the worst year for U.S. stocks since 2002 during the tech bust.1 But whether who wins or loses their election campaigns, or which political party gains control, should that really matter for an informed investor with disciplined planning strategies and practices?
Markets Work
Investors instinctively want to make reactive changes from fear or greed due to various media opinions, attempting to either avoid losses or make bigger gains from potential changes in policy. But modern financial markets, processing millions of trades daily, are highly efficient information-processing machines expressed through current share prices of each company on the exchanges.
Buyers and sellers both have some information they use for trading. The aggregate of all trades using that collective information with money at risk sets “fair” prices. Outguessing security prices and price movements is very difficult.2 Evidence shows that the market’s pricing power, after costs, works against even the most skilled professionals with the best resources that money can buy.3
The 2016 presidential election is a prime anecdote. Many columnists and pundits at the time predicted market disaster, speculating that stocks and the sky would fall if terrible Trump were elected president.4 The day following Trump’s surprise win, however, the S&P 500 Index closed 1.1% higher and continued higher not only through that year, but into and through the next year.
But even if that popular narrative occurred, an investor who had correctly predicted the election outcome may not have also predicted the market’s directional move upward. Surprises are, by definition, unpredictable — so that either way things turn out, investing outcomes don’t necessarily turn out in a consistently clear-cut way that increases the value of your portfolio.
Should non-Presidential midterm congressional elections be any different? For this November’s elections, market strategists and news media once again will present highly convincing arguments not only about who will win but also the consequential market impact. However, data for the stock market going back to 1926 shows that extreme returns, negative or positive, rarely occur.
The party gaining control hasn’t been a reliable driver of direction or magnitude of market movements from the election month data. Returns in election months don’t differ much from non-election months. All that political sound and fury, signifies not all that much for investing.
Exhibit 1 shows S&P 500 Index returns by month back to January 1926. Each horizontal dash represents one month, by increasing market returns in 1% increments from left to right.5 Blue and red horizontal lines represent those months with a midterm election. Red is for when Republicans won or maintained Congressional majorities in both chambers, and blue is the same for Democrats. Striped boxes indicate mixed house control. We see that regardless of which party controls, that election month returns varied within a normal return range.
Exhibit 1: Histogram of S&P 500 Index Returns and Mid-Term Election Months by Party
January 1926–June 2022, Monthly Returns
Source: Dimensional Fund Advisors. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.
Disciplined Investing Ignores Elections
The media’s business goal is to distract you with daily, monthly and annual market information to briefly capture your attention long enough to read the ads they sell. What matters most to you as an investor is how your wealth grows over your lifetime and does so most reliably so you don’t die broke. Exhibit 2 illustrates the hypothetical growth of wealth of $1 in an S&P 500 Index equivalent beginning January 1926. It also shows which party by year has Congressional control. Time and again, periods of significant growth and significant decline occurred during the majorities of both parties. No party pattern is apparent. Markets provide returns irrespective of the party in power.
Exhibit 2: Growth of U.S. Stock Market and Congressional Party Control
Growth of $1 for S&P 500 Index hypothetical returns, July 1926 – June 2021
Source: Dimensional Fund Advisors. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.
Nearly a century of U.S. stock market returns suggests that investing based on which political party will control or may control Congress does not improve your investing outcomes. Congressional politics is only one factor of hundreds that set prices as they trade on the markets.
Businesses continue to operate for profit, providing goods and services for people to buy regardless of, and often despite of, a sometimes-hostile political environment. Not only Congress, but dictates by Presidents, state legislatures, government bureaucracies, regulatory agencies, and foreign governments will impact the future profitability of businesses and hence the price of their shares. But so will interest rate changes, technological advances, climate disasters, geopolitical events, and hundreds of factors and future events impossible to know or even imagine, like Covid lockdowns.
Realistic Planning for Returns
Portfolio returns that you realize depend not only on your approach (such as indexing the broad U.S. stock market), but whether you remain invested, and the ongoing consistency of your strategy over time. Economic theory tells us your expected return is always positive, even if a realized return has not been positive for months and occasionally years. (In that case, keep extending your evaluation period to correspond with a sensible investment policy of at least 5 or 10 years).
In 15 of the last 24 U. S. mid-term elections, we see in Exhibit 3 that returns were positive. 9 years were negative. The average return was 8.6%, and the average 4th quarter return was 6.5%. But only those who were invested and stayed invested, benefited. This year, if only 6.5% occurs, your year’s return likely will be negative. But a bad outcome does not mean that your planning was bad. Negative years periodically due to market volatility are part of a normal investing experience.
Exhibit 3: Market Returns Mid-Term Election Years
S&P 500 Index of U.S. Large Stocks: 1926-2021
Exhibit 4: Market Return, Year Following Mid-Term Elections
S&P 500 Index of U.S. Large Stocks: 1926-2021
Source: Dimensional Fund Advisors. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. Source: © S&P Dow Jones Indices LLC, a division of S&P Global.
For those whose planning horizon extends beyond a particular quarter, Exhibit 4 shows that in 22 of the last 24 years that followed Congressional mid-term elections, outcomes were positive, averaging 18.5%. That could offset 2022’s declines for many investors. Regardless of the averages, stocks investing tend to reward those who are disciplined no matter who controls the U.S. House or Senate, especially when you add in all those positive years that follow U.S. Presidential year elections — plus all those many years when there are no Federal elections going on at all.
Conclusion
Equity markets offer an excellent way to grow your wealth and have a financially secure future. But intense competition among participants creates short-term uncertainty. Successful investing is a long-term endeavor and takes a patient view for planning. Investment decisions with undue attention to election outcomes is not smart. At best, positive years may be due to random luck. At worst, you can miss returns easily gained by simply staying in your seat and remaining invested.
While investing is always uncertain, there is at least one certainty: to capture market returns, you must minimize costly mistakes. To do that, one rule is to remain invested over many years, because negative years will happen. Have a sufficiently informed allocation strategy suitable for your risk preference and a willingness to be patient. With the right planning professional and time horizon, your outcomes can yield a successful financial experience and confidence for your peace of mind.
NOTES
1Hannan Miao, Wall Street Journal (October 2, 2022), 11664660238.
2This is known as the efficient market theory, which postulates that market prices reflect the knowledge and expectations of all investors and new information is almost instantaneously priced into a security.
3For instance, only 18% of US-domiciled equity funds and 15% of fixed income funds have both survived and outperformed their benchmarks over the past 20 years. The Mutual Fund Landscape 2022, Dimensional Fund Advisors. That survey is updated annually and results have been reasonably consistent for over a decade.
4Examples include: “A Trump win would sink stocks. What about Clinton?” CNN Money, 10/4/16, “What do financial markets think of the 2016 election?” Brookings Institution, 10/21/16, “What Happens to the Markets if Donald Trump Wins?” New York Times, 10/31/16.
5Dashes representing returns for a given month are stacked in ascending order of return within each column, with highest return within that range on top. Gray boxes represent non-election month returns.