We are getting a lot of questions about what will happen to the stock and bond markets with the US Presidential election coming up in less than two months. Concerns are certainly amplified due to health and economic concerns about the COVID-19 pandemic.
Trying to outguess the market is often a losing game. Current market prices offer an up-to-the-minute snapshot of the aggregate expectations of hundreds of millions of market participants. This includes expectations about the outcome and impact of elections. While unanticipated future events—surprises relative to those expectations—may trigger price changes in the future, the nature of these surprises cannot be known by investors today. As a result, it is difficult, if not impossible, to systematically benefit from trying to identify mispriced securities. This suggests it is unlikely that investors can gain an edge by attempting to predict what will happen to the stock market after a presidential election.
STOCK MARKET RETURNS IN AN ELECTION YEAR
What does research show about the impact of US Presidential elections on yearly investment returns? According to Vanguard Group, election years have no statistically significant impact on market returns.
Comparing election years versus nonelection years: 60% stock/40% bond portfolio returns show no significant statistical difference.
Source: Vanguard calculations, based on data from Global Financial Data as of December 31, 2019. Data represents the 60% GFD US-100 Index and 40% GFD US Bond Index, as calculated by historical data provider Global Financial Data. The GFD US-100 Index includes the top 25 companies from 1825 to 1850, the top 50 companies from 1850 to 1900, and the top 100 companies by capitalization from 1900 to the present. In January of each year, the largest companies in the United States are ranked by capitalization, and the largest companies are chosen to be part of the index for that year. The next year, a new list is created and it is chain-linked to the previous year’s index. The index is capitalization-weighted, and both price and return indices are calculated. The GFD US Bond Index uses the U.S. government bond closest to a 10-year maturity without exceeding 10 years from 1786 until 1941 and the Federal Reserve’s 10-year constant maturity yield beginning in 1941. Each month, changes in the price of the underlying bond are calculated to determine any capital gain or loss. The index assumes a laddered portfolio that pays interest on a monthly basis.
Note: Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
VOLATILITY IN AN ELECTION YEAR
What about volatility? We’ve seen high levels of volatility this year, for sure. But Vanguard’s analysis of monthly returns in election years failed to detect any performance pattern.
Equity volatility has been lower in the weeks before and after an election.
Annualized S&P 500 Index volatility
Full time period: 15.7%
Well, enough about the short term, what do presidential cycles tell us about long-term investment returns?
LONG-TERM INVESTING: BULLS & BEARS ≠ DONKEYS & ELEPHANTS
Predictions about presidential elections and the stock market often focus on which party or candidate will be “better for the market” over the long run. The table shows the growth of one dollar invested in the S&P 500 Index over nine decades and 16 presidencies (from Coolidge to Trump). This data does not suggest an obvious pattern of long-term stock market performance based upon which party holds the Oval Office. The key takeaway here is that over the long run, the market has provided substantial returns regardless of who controlled the executive branch.
Equity markets can help investors grow their assets, but investing is a long-term endeavor. Trying to make investment decisions based upon the outcome of presidential elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, in order to pursue investment returns.
Source: Dimensional Fund Advisors LP.
All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.
Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. There is no guarantee an investing strategy will be successful.
Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. The S&P data is provided by Standard & Poor’s Index Services Group.