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Craig Fehr, CFA - Principal, Investment Strategist
Nela Richardson, Ph.D. - Principal, Investment Strategist
Angelo Kourkafas, CFA - Analyst, Investment Strategy
Sloane Marshall, Associate Analyst
The 2020 U.S. presidential election is dominating the headlines and capturing investors’ attention, given the polarized political environment and disparate policy principles of the candidates. Despite this, we don’t think the outcome will be the determining factor in the broader direction of the financial markets over the long run.
Does this election matter? Yes.
Will the stock market have short-term reactions to the policy proposals and election uncertainties? We think so.
But there is good news for long-term investors. History shows us it’s the fundamental factors – such as economic growth, rising corporate profits and interest rate conditions – that are the more powerful and lasting determinant of market performance. When it comes to your portfolio, ensure your financial goals, not election uncertainties, are your guide.
Here are four key facts to know about this election:
We don’t think this election presents an exclusively good or bad outcome for the financial markets. Historically, the stock market has returned 13.9% during U.S. election years. Looking more closely, the average return in the six months leading up to November elections was 6.1%, and the average return in the following six months was 6.5%.1
The average total return for stocks in the two years following an election year is 10.5% per year, with only four instances in which the market was down over that two-year period. This indicates an election outcome doesn’t represent a larger downside catalyst.1
In elections since World War II that have resulted in a change in the party occupying the White House, the average stock market return in the following year was 5.8%. When the incumbent party retained the White House, the average return was 15.5%. This includes four instances in which Democrats retained the White House and five times when Republicans retained the presidency.
When we look historically at an incumbent Republican win (a potential outcome in this election), the average market return in the following year was 8.6%. When the incumbent Republican party lost and the Democratic party moved into the Oval Office, the market averaged a return of 14.1% in the following year. The bottom line: Markets have performed well following a wide variety of election outcomes.2
We expect market fluctuations to increase as we approach the election, given the polarized political climate and potential policy shifts. Historically, market volatility has risen in the two months ahead of an election but has subsided by an average of 16% in the month afterward,3 with smaller post-election fluctuations reflecting reduced political uncertainty regardless of the outcome. We suspect the same can play out this time, with election anxiety being replaced by a focus on the economic recovery, which may instigate volatility in its own right. However, a disputed or inconclusive result on Nov. 3 (similar to the 2000 U.S. election recount) would likely produce elevated market volatility that extends beyond election day.
This election highlights the sizeable chasm between Trump and Biden on key policy elements such as taxes, regulation and the government’s role in economic growth. These differing policy principles are perhaps more acute given the existing pandemic and current political environment in the U.S., but they are not new or unique to this election.
The election outcome poses different policy approaches, but in our view, neither administration will solely determine the fate of the economy or the financial markets. It’s worth remembering that campaign rhetoric often differs from actual legislation, as proposals can change considerably as they move through our democratic process.
White House policies can help shape the economic terrain, but history shows that broader path has been rather similar over time, even as the party in the Oval Office has shifted. We attribute this to the composition of the U.S. economy, which is principally made up of consumer spending and business investment. Also, the nature of the U.S. democratic system largely limits the ability of one administration or political party to fully re-engineer the economy, keeping consumer and business behaviour behind the wheel over time.
While we don’t think this election is the determining factor in the economy’s long-term fate, these three potential scenarios will, in our view, pose the following implications:
Likely a continuation of existing policies, with a split Congress tempering any major legislative initiatives. Policy implications include:
Biden's executive agenda will look to roll back some of Trump’s more recent policies, but a split Congress will likely prevent a sweeping or swift policy overhaul, with gridlock producing slightly more moderate policy shifts. Implications include:
A possible scenario includes a Democratic sweep that would result in White House and congressional control. This would likely fast-track some of Biden’s policies mentioned above, perhaps most notably on taxes, regulation and fiscal spending initiatives.
While the campaign and the headlines will highlight the dramatic differences, we do think there will be some consistent outcomes between the administrations, including a tough trade stance with China, support for a combination of fiscal and monetary (low interest rates) stimulus to aid the recovery, infrastructure spending and ongoing deficit spending, adding to high government debt levels.
Since World War II, the average annual return of the U.S. stock market has been 11.1%. It has performed well under both Republican and Democratic presidents, with the strongest annualized returns occurring during the Reagan (R), Eisenhower (R), Obama (D), Clinton (D) and Ford (R) presidencies.1,3
History shows that over time, market performance is driven principally by fundamentals, not elections. Trends in economic conditions, corporate profits and interest rates have been the more powerful and lasting guide for investment values. We think the following fundamental conditions – though not immune to U.S. presidential policies – will set the broader course for the markets regardless of the election outcome:
A gradual but sustained economic recovery – After a partial initial snapback from the spring shutdown, we think the economy will gradually recover amid slowly declining unemployment and eventual renewed business spending. Fiscal aid, while having a different complexion depending on the party, will be a necessary component of the early stage recovery that the president will preside over early in the term.
Rising corporate profitability – Various industries and business sizes will navigate this environment differently given the disproportionate pandemic impacts. Nevertheless, corporate profits have shown an ability to flourish under all varieties of Washington control. While corporate tax rates likely hang in the balance with this election and a rate increase would pose an initial hit to profitability that would instigate stock price volatility, we don’t think the longer-term corporate earnings rebound will be derailed by a hike to the proposed 28% tax rate.
Ongoing monetary policy stimulus – U.S. Federal Reserve policy stimulus has been a key component of the market rebound this year. We think highly supportive monetary stimulus and ultra-low interest rates will persist. Monetary policy is governed by employment conditions, inflation trends and financial conditions, all of which we believe will support ongoing stimulus in the coming years.
Since 1960, there have been five instances in which the U.S. economy was in recession or the stock market declined 20% in an election year. The incumbent party lost each of those elections, highlighting the weight voters place on economic and personal financial conditions.
It’s worth noting, however, that there are some differences this time:
This does not mean conditions are ideal, but this may create a different environment versus past instances where some voters attributed economic hardships more directly to the incumbent party.
Political changes occur frequently, and your investment timeline will likely span numerous U.S. presidential terms. Ensure you’re making decisions aligned with your financial goals rather than election headlines or political parties.
Action for investors: We do think U.S. election uncertainty will be a catalyst for market fluctuations. However, staying invested and building an appropriately balanced, diversified portfolio can be an effective strategy for navigating market volatility.
We don’t think being “all in” or “all out” of the market is an effective strategy for the long run. The candidates’ disparate policies pose some unique implications for certain sectors such as energy and health care, but history has shown us that each industry can survive, and quality companies can thrive, under a range of political scenarios.
Action for investors: We think the economic backdrop warrants appropriate balance across equity sectors, while the broader global rebound still supports some diversified exposure to international markets.
Aggressive Fed stimulus and additional deficit spending raise the prospects of higher inflation down the road. We think inflation will remain subdued as the economy navigates the pandemic and gathers its footing in the coming years, but currently policies pose potential implications for long-run inflation.
Action for investors: An appropriate allocation to equities, along with exposure to those with rising dividend potential, can help position for the impacts of inflation over time.
1 Source: Bloomberg, S&P 500 Index total return.
2 Source: Ned Davis Research.
3 Volatility measured by the CBOE Volatility Index.
Diversification does not guarantee a profit or protect against loss in declining markets.
Past performance is not a guarantee of future results. Special risks are inherent in international investing, including those related to currency fluctuations and foreign political and economic events.
Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal.
Dividends can be increased, decreased or eliminated at any point without notice.
Prepare for normal swings in the market by staying diversified in high quality investments and maintaining the appropriate mix of equities and bonds for your comfort with risk to help keep your portfolio growing in 2020 and beyond.