Addressing Election Anxiety

Two years ago, the Federal Reserve's bold move to raise interest rates sparked turbulence in financial markets, causing significant stock and bond declines. Today, U.S. large-cap stocks are soaring to new heights, boosted by the economy's resilience and the promise of technological advancements. Amidst this backdrop, market sentiment fluctuates between hope and caution, influenced by concerns about inflation, monetary policy shifts, and geopolitical tensions. Adding to the intrigue, the 2024 U.S. presidential election features a remarkable rematch between former President Donald Trump and President Joe Biden, with uncertainties surrounding Trump's legal challenges adding to the anticipation of the unfolding political landscape. As we navigate the complexities of the market amid these significant developments, investors wonder: what does this election year mean for my portfolio?

We reviewed historical market performance across election and non-election years to generate insights about what might lie ahead for markets. Our analysis included a detailed examination of election outcomes and how that could impact post-election performance.

From our study of the markets, we believe this election year’s outcome will likely have a limited impact on the market 12 months from now. However, on a near-term basis, there may be policy-driven impacts on specific sectors and increased market volatility. How might this impact individual investors? Read on for three crucial insights.

Elections Don’t Impact Long-Term Market Performance, Though They Create Short-Term Market Volatility

While elections typically usher in short-term market fluctuations, we believe they do not directly impact mid- to long-term financial market performance. As a result, we believe investors should maintain a steady approach and prioritize long-term investment objectives to navigate through short-term volatility rather than being swayed by election-related turbulence (FIGURE 1).

A general upward trend in S&P 500 performance in both election and non-election years suggests election outcome has minimal impact on the market. This is not the case for daily market volatility, which, in election years, is nearly double that of non-election years. We can discern daily market volatility by looking at performance fluctuations. There are more significant swings in presidential election years than non-presidential election years.

FIGURE 1: S&P 500 Average Performance: Presidential Election Years vs. Non-Presidential Election Years (1960-2023)

A general upward trend in S&P 500 performance in both election and non-election years suggests election outcome has minimal impact on the market. This is not the case for daily market volatility.

Typically, in election years, the stock market tends to bottom out when a winner emerges as a favorite to win. This is generally around May, although the exact timing varies widely. 2020 is an exception – it was distorted by the impact of COVID-19.

Another measure of volatility is intra-year drawdown or correction, measured from peak to trough within a year. On average, election-years see corrections of about 16.5% compared to 13.6% in non-election years. Years marked by intensified corrections often coincide with the incumbent party losing the election, reflecting troubled economic conditions and loss of voter confidence.

Despite the magnitude of these corrections, 12 months later, performances are generally in line with each other, at 23.4% versus 25.1%. This suggests that volatility is short-lived and does not meaningfully impact post-election returns (Figure 2). For instance, after the 2016 election of Donald Trump, equity futures signaled heavy selling pressure in the early hours, yet the S&P 500 ended up 1.1% that day. The index did better after the election of Joe Biden, gaining 2.2% the next day. Above-average gains persisted during the following months for both candidates.

FIGURE 2: Market Corrections During Presidential Election Years: Incumbent Party Won or Lost (1960-2020)

History shows that when the incumbent party loses the election, the market experiences intensified corrections prior to Election Day. One year later, market performance is virtually the same, suggesting volatility is short-lived.

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In Impact on Markets, Economic Indicators Trump Political Events

We categorize post-election market outcomes into three distinct scenarios:

1. Unified Government: The President, House Majority, and Senate Majority are all the same party.    
2. Unified Congress: The Senate Majority and the President are the same party, and that party is different than the House Majority.
3. Split Congress: The House Majority and the Senate Majority are different parties.

We ran regression analyses against the relative performance for years under these three different election scenarios to see if those outcomes have prediction power for the market return against long-run averages. Despite common investor beliefs that a Republican or Democratic sweep would heavily impact the market, our data reveals a statistically significant relationship only in the split congress scenario and not in a “sweep” (Figure3).

FIGURE 3: S&P 500 Average Annual Performance Under Partisan Control Scenarios (1965-2023)

Despite common investor beliefs that a Republican or Democratic sweep would heavily impact the market, our data reveals a statistically significant relationship only in the split congress scenario.

We believe economic indicators such as GDP growth, unemployment rates, and inflation trends play a significant role in shaping market returns - often exerting a stronger influence than the outcomes of elections. Investors typically focus more on the underlying economic fundamentals and inflationary pressures when making investment decisions, as these factors may have a more direct and immediate impact on corporate earnings and market valuations. We conducted a statistical significance calculation between the average 3-month S&P 500 return after election day and macroeconomic factors like GDP growth and inflation, and the data confirmed the important connection between those two (Figure 4). Therefore, our analysis underscores the enduring correlation between economic fundamentals and market performance, emphasizing the primacy of sound financial principles in guiding investment decisions.

FIGURE 4: Average 3-Months S&P 500 Returns Post-Election Day Relationship to Economic Regime

Compared to the statistical significance of election results’ impact on markets, economic indicators show greater impact.

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‍Politics’ Greatest Impact on Markets is  on the Sector, Industry, and Sub-Industry Levels due to Policy Changes

Significant policy changes typically require one party to control both branches of government, potentially leading to targeted reforms affecting specific sectors. The following are some of the critical policy issues with high importance to market segments typically seen throughout the nomination process:

• Taxes: Corporate, capital gains or income tax changes can influence investor behavior and market dynamics.
• Spending: Stimulus measures toward infrastructure, and defense can impact various sectors.
• Trade: Shifts in trade agreements or tariffs can impact on the profitability of companies with international exposure.
• Healthcare: Reforms in healthcare policy, such as drug pricing regulations, can affect pharmaceutical and healthcare company performance.
• Immigration: Changes in immigration policies can influence labor availability, consumer demographics, impacting industries reliant on workforce dynamics and consumer spending patterns. It can also impact fundings towards border security, immigration enforcement, etc.
• Energy: Changes in energy regulations or incentives can affect the profitability of various energy-related companies.
• Tech Regulation: Increased regulatory scrutiny on technology firms can influence investor confidence and tech stock performance.
• Infrastructure Cybersecurity: Measures to enhance cybersecurity for critical infrastructure can affect the performance of cybersecurity firms.
• Climate Change: Regulations addressing climate change, such as carbon pricing, can impact industries like energy and transportation, affecting related stocks.

Each election has different key issues and priorities for the candidates and parties involved. Identifying those key issues and tracking the associated stocks' performance can provide unique insight into election outcomes. Traditionally, we observe outperformance from the winning parties’ constituents in the months leading up to the election and the immediate month post-election.

However, the same group of stocks may not sustain their outperform post-election, especially throughout the entire presidential term. For instance, in 2016, Obama’s re-election signaled the implementation of the Affordable Care Act, meaningfully changing the earnings profile for healthcare companies as the government put significant resources into the industry. For Trump, in 2017, tax reform changed the return on invested capital (ROIC) on high-tax companies specifically. For Biden, it was renewable energy.

It’s important to note that not all issues that are focus areas during an election year can translate into long-term earning benefits. After all, earnings growth and macro economics often trump policy over the long run.

For instance, the Biden administration is generally considered bullish for clean energy: it supports policies transitioning the U.S. away from fossil fuels by raising the cost of fossil fuel production through regulation and higher taxes while lowering the cost of renewable energy through subsidies. Conversely, Trump’s administration supported traditional fossil fuel energy and emphasized energy independence.

Despite their policy positions, the performance of renewable energy spiked during Trump’s administration while traditional energy (represented by the S&P 500 fell). In addition, renewable energy performance has fallen during Biden’s administration and traditional energy has risen.

One key reason, as mentioned before, is that macroeconomic factors tend to outweigh policy directions, with variables such as oil supply and demand dynamics, interest rates, and geopolitics proving to have a more significant impact than U.S. domestic energy policy initiatives. (Figure 5).

FIGURE 5: 2020 Energy Policy vs. S&P 500 Index

Earnings growth and macroeconomic factors matter much more than monetary policy over the long run, as we can see with the performance of clean energy and traditional energy through the Trump and Biden Presidencies.

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Conclusion

In conclusion, while elections may stir short-term market fluctuations, a deeper examination reveals the enduring resilience of financial markets amidst political uncertainty. We believe investors can confidently navigate election cycles by anchoring investment decisions in economic fundamentals, monitoring sector-specific dynamics, and maintaining a long-term perspective. Should you ever have questions about your unique situation, we encourage you to reach out to Balentine to discuss.