How Can the Election Outcome Influence Markets?

November 2020 is fast approaching, and with it comes a U.S. presidential election affected by a drastic wave of social, economic and political headwinds and a worldwide global health crisis. Few could have predicted how dramatically different our world is today compared to just four years ago, during the last presidential election cycle.

But even in these unprecedented times, investors around the world are asking some very familiar questions. Among them: Which candidate and political party is going to win the presidential race? and How will that outcome affect the markets?

Now, as in every presidential election cycle, no one knows the answers. Taking a look at historical trends, however, can add context to the ways we think about the relationship between stock market performance and the presidential election outcome.

Looking at Performance

Overall, presidential elections can be influenced by the stock market in powerful ways—especially when a second term is on the table.

Research shows that stock market performance in the run-up to an election tends to be a more significant regulator of an incumbent’s outcomes than important economic variables such as GDP, inflation and unemployment. (In some instances, net percentage changes in the stock market even correlate with the incumbent’s margin of victory or defeat.)

There are plenty of other variables involved in an individual election, however. In fact, voters’ propensity to keep an existing president in office may be less related to any financial indicator than to their collective “social mood” and the factors behind it. That is, the more positive they feel about their economic circumstances, the more likely they are to want to do things like buy stocks—helping drive up the market—and vote for a sitting president to keep the office.

Regardless of who’s running for election, stock performance tends to see uplift in election years at large: Overall, no matter which party holds office, the S&P 500 has made gains in 78% of U.S. presidential election years since World War II. The average gain is around 6%.

This is not to say that the outcome by party has no effect. The effect just varies depending on what’s being measured, as researchers approach the topic through different lenses. For example:

• One analysis found that in both the 2000 and 2004 presidential elections, as well as the entire 1880-2004 period, a Republican victory raised equity values by about 2%. This may be attributable to traders anticipating more favorable treatment for businesses.
• Another found that since 1927, excess return in the stock market is significantly higher—ranging between 9% and 16%—under Democratic vs. Republican presidencies. The researchers conclude that “the difference in returns through the political cycle is therefore a puzzle.”

A Matter of Perception

The puzzle of election outcomes and stock-market behavior is an origin problem. Are presidential votes motivated by voters’ perception of each party’s policies and their impact on the market? Or are market swings a response to voters’ circumstances, which they perceive a presidential candidate as being able to continue or improve?

In either scenario, their perceptions of a party’s influence always don’t align with how their economic realities play out. And that shows itself in market behavior overall, which is less tied to wins and losses for incumbents or political parties than it is to a more general long-term trajectory of upward growth.

Data shows that in presidential elections from 1928 to 2016, for example, a $1,000 investment in the S&P 500 Index at the start of each election year appreciated over the four years that followed in 20 out of 23 elections.

Notably, however, the three-of-23 elections in which equity investments proved unprofitable all preceded or coincided with major negative economic events: 1928 and the Great Depression; 2000 and the tech bubble; and 2008 and the Global Financial Crisis.

Looking Forward

In this highly unpredictable era, no one knows how a January 1, 2020 equity investment will perform over the next four years (and what that will reflect about the social, economic, and political environment surrounding the November 3 election).

The world can change a lot in one presidential term, and the election outcome is just one of many contextual factors that will play into how the stock market performs beyond November. Even in these unfamiliar, fast-changing times, long-term thinking can help investors stay more focused on their goals than on unanswerable questions about the future.