Investors and media habitually look for a connection between who wins the U.S. White House and whether stocks will go up or down. But predictions based on election outcomes are unlikely to result in consistently winning bets that provide excess returns reliably.
Election Day in the U.S. has come and gone. Some voters are happy, others are not. While outcomes of many national and state elections held surprises and disappointments, plenty of opinions and predictions were floated in the preceding days. Discussions frequently included the potential election impact on markets. But should major elections seriously influence decisions regarding portfolio planning?
We believe that speculation that leads to substantial changes to a well-informed investment strategy based on changing political winds hoping for extra profits or avoiding losses is likely to prove futile. For context, think of financial markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that already incorporate all of investors’ collective expectations including matters and situations far removed from who happens to be president of America or which political party is in power. This makes outguessing market prices, individually or collectively, expecting to out-perform most other investors (or their computer algorithms)–for the market or any market segment – very difficult to do over and over.1
For the stock market going back to 1926, research shows in those months when presidential elections took place, returns have not been that different than any other month. As we look at the data, the aggregate of all those outcomes approximate a normal “bell curve” distribution. Most election months did not produce extreme returns in one way or the other. And which president or party happening to win was not a reliable driver for the direction or magnitude of market movements in those months.
Exhibit 1: U.S. Presidential Elections and November Returns for U.S. Stocks
January 1926–June 2020
Past performance is no guarantee or assurance of future results. This material is in relation to the US market and contains analysis specific to the US. In U.S. dollars.
Source: Distribution of Monthly Returns for Fama/French Total US Market Research Index provided by Kenneth French and available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. This value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.
Exhibit 1 shows the frequency of monthly returns (expressed in 1% increments) for a broad-market index of U.S. stocks from January 1926–June 2020. Each horizontal dash represents one month, and each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months in which returns were between 0% and 1%). The blue and red horizontal lines represent months during which a presidential election was held, with red meaning a Republican won the White House and blue representing the same for Democrats. This graphic illustrates that election month returns are well dispersed throughout the columns, with no clear pattern based on which party won the presidency.
It’s natural to seek a connection between who wins the White House and to guess which way stocks will go. But shareholders are investing in companies, not a political party. And companies focus on serving their customers and getting their businesses to grow profitably, either regardless of or despite who inhabits the White House.
During an election cycle, profitability expectations of public companies are continuously reflected in their daily stock prices. Surprises are, by definition, unpredictable — and completely random occurrences rarely lead to clear-cut investment outcomes within a month’s time. For that reason, we believe that a smartly diversified, globally allocated approach for investing is best for confidently realizing important goals such as a flow of income that you can expect during what may be a very long retirement with health care related needs.
Modern history shows that stocks have rewarded investors with a long term focus, through both Democratic and Republican presidencies. Needless speculation about election outcomes, or how results from a recent election might unfold, is unlikely to result in excess returns that you can spend. Perversely, underperformance or costly mistakes you may regret are equally possible. Accordingly, we recommend that most wealth planning clients maintain a strategic approach scientifically grounded in a sensible economic philosophy within a structured investment management process they can stick with.
1The performance of active investment managers casts doubt on the ability of investors to consistently outguess market prices. For more on this topic, see Fama and French (2009), “Luck versus Skill in Mutual Fund Performance.”