Be Not Afraid, Part 3: Elections and Markets

Tuesday, October 27, 2020

By: Christopher Cline

We are one week away from what many are calling the most consequential election of our lifetimes. And as November 3rd approaches, we Americans have more stressors on our plates leading into an election than perhaps at any point in our history: from the pandemic to the unrest over social justice to changing geopolitics, just to name a few. All of these are piled on top of an extremely polarized political climate and together are compounding to create a collective sense of gloom.

From our perspective as your financial advisor, a worrying aspect of this gloom is seeing it extend to people’s views of their investments. A recent white paper from Hartford Funds indicates that “45% of investors said they plan to make changes to their investments because of the election.” But as we wrote about four years ago in our first “Be Not Afraid” article, making such moves is probably not a good idea.

As a recent Vanguard report points out, the returns from a 60% stock, 40% bond portfolio show no statistical difference between election and nonelection years. In fact, market gyrations are more muted in the months surrounding an election, contrary to what one might expect. Specifically, from January 1, 1964, to December 31, 2019, the S&P 500’s annualized volatility was 13.8% in the 100 days both before and after a presidential election, lower than the 15.7% annualized volatility for the full period.

As always, our friends at Dimensional Fund Advisors have done a fair bit of research on the subject. They point out that nearly a century of returns from the U.S. stock market shows that stocks have trended upward across administrations from both parties. More specifically, out of 23 election years since 1926, the only years in which returns were negative from the S&P 500 were 1932 (the year of the Great Depression), 1940 (World War II), 2000 (the tech bubble) and 2008 (the Great Recession). The average return during presidential election years was 11.3% over the period between 1926 and 2019. Also, somewhat interesting (although not especially helpful) is the fact that, on average, the markets have performed better under Democratic presidents than Republicans (although the administration that saw the highest returns was Gerald Ford’s). Go figure.

This is not to say, of course, that administration changes don’t affect investment performance. Fiscal decisions like infrastructure spending and tax increases and decreases can cause large-scale economic swings that in turn can affect investment prices. However, most of these changes require legislation, not Executive Order. Bank of America’s Chief Investment Office recently issued a white paper regarding the effect of elections on municipal bonds. While it points out that municipal bonds may react favorably to a Democratic presidential and Senate win because they could mean increases in tax rates and more stimulus to state and local governments, it also suggests there may be little downside risk for munis with a Republican presidential and Senate win, because some form of stimulus will still probably pass, and there is low probability of tax rates moving lower. In other words, either outcome might be beneficial for that investment, but we won’t know until we see specific legislation enacted.

This has been and continues to be a bitter presidential contest. The pandemic is in full swing and a vaccine (though close) may not be available for some time. Unemployment is high. All of these facts create fear and fatigue in all of us. But it is important to not let emotions drive our investment decisions, particularly now when we face a potentially protracted vote tally and as we move into the winter months. Just remember that the data is on your side, we are here to help, and we will come out of this together. Be not afraid.