Every four years, the intersection of power and money lead Wall Street to churn out election-related research pontificating what impact politicking has on the market. These articles and papers attempt to answer the question, will the outcome of this year’s presidential election be good or bad for stocks?
We learn some useful trivia answers from these studies. For example, historical stock market performance has been consistently higher in the third year of a presidential term than years one, two or four—regardless of who is in office. We also know that the S&P 500 Index has gained an average of 8% in the years a Democrat has held the highest office, compared with a 5% gain under Republican presidents. While fascinating, these statistics are far from what financial economists would deem “significant.” Over the course of U.S. history, there have only been 56 presidential elections, 22 in which there was no incumbent—far too few from which to draw reliable investment conclusions.
Interestingly, David Booth, co-founder of Dimensional Fund Advisors, was one of the first academics to suggest stock markets may actually predict elections winners, and not the other way round.[1] In fact, one independent study credits the stock market for correctly forecasting 90 percent of presidential elections—with only three exceptions since 1900.[2]
Other researchers have come to similar conclusions. Specifically, academics affiliated with the Socionomics Institute and Emory University School of Medicine studied the relationship between the “social mood” of the U.S., as indicated by a rising or falling stock market, and an incumbent’s re-election chances. They found that a net gain in the stock market (i.e., positive social mood) during the three years preceding an election is predictive of an incumbent’s victory, and a net stock market decline as predictive of the incumbent’s defeat.
Importantly, the study found that social mood is even more powerful than economic growth, inflation, or unemployment in determining voter behavior.[3]
So what are we to make of all this? Elections are inherently emotional, which means there is money to be made catering to those emotions. The investment reality, however, is neither risk nor return varies significantly from the time before an election and after. Let the pundits worry about the market’s response to whichever candidate is trending; our focus will remain on your goals, diversification, discipline and sound portfolio construction. That’s a trend that will always be in style at Vista.
[1] Booth, David G. “Presidential Elections and Market Returns.” Dimensional Fund Advisors. Dimensional Fund Advisors. September 2004.
[2] Fox, Lauren. “Stock Market Picks 90 Percent of Presidential Elections.” U.S. News & World Report. February 24, 2012.
[3] Prechter, Robert R., Deepak Goel, Wayne D. Parker and Matthew Lampert. “Social Mood, Stock Market Performance and U.S. Presidential Elections: A Socionomic Perspective on Voting Results.” SAGE Open, Vol.2 No.7, November 2012.