As the November election approaches, we are receiving more questions about how this event can impact investment portfolios. Some individuals have a specific election outcome they perceive as cataclysmic for the economy and markets. Other individuals are more generally concerned about the volatility that could surface in, what appears to be, a highly contested race with a lot at stake.
There is no doubt that elections are impactful events that shape the future of our society. Despite that, we are not altering our portfolios and I will share the reasons why. Let me first state that I do not want to trivialize the impact that government policy can have on many aspects of our lives. All that I want to share is that near-term economic growth and equity market performance are not typically an area where the government exercises much influence. Our understanding of the data tells us that the link between government policy and economic growth or equity market performance is weaker than many believe and that any attempt to alter a portfolio based on the expected impact of government policy will likely be counterproductive. Long-term investors are much better off to stay invested with a diversified portfolio.
There is a long history of political parties and presidents trying to take credit for periods of strong economic growth and market performance and pass the blame for weak ones. The truth is, neither Democrats nor Republicans have robust evidence that their presidential candidates have delivered superior market returns. According to Vanguard, since 1870, a 60% equity and 40% bond portfolio has returned 8.2% under Republican presidents and 8.4% under Democratic presidents. While Democrats come out slightly ahead by that measure, the lead is not statistically significant and has no predictive value. Through 11 of the last 13 presidential terms, equity markets have typically returned between 9% (during Kennedy) and slightly over 20% (during Ford) per year with a good mix of Democrats and Republicans in between (source: Invesco, Haver). The two presidential terms not included above represent exceptions, in that they coincided with negative market performance. Those were the terms of George W Bush and Richard Nixon. While both were Republican presidents, it would be unreasonable to use that to build a strong argument against Republican economic policy. Both of these presidents had terms that coincided with significant economic shocks that had developed out of a complex set of factors that were likely out of the control of either administration. The takeaway is that complex forces outside of presidential control like stagflation or the Great Financial Crisis have far more impact on the economy than any Presidential agenda.
At the end of the day, the market’s long-term trend has been up, and that trend has not been interrupted by any particular president or political party. I interpret the lack of correlation between politics and investment results through how independently American corporate and governmental spheres operate. On a day-to-day basis, businesses are simply trying to operate and grow in a way that is profitable for their owners. The government only gets involved in their activity to collect taxes and set some foundational rules and boundaries for companies to operate within as they pursue their prime directive of profit. As long as these foundational rules remain stable and easy to understand, businesses can continue to operate effectively through varying political landscapes. It is possible to conceive of drastic enough changes to laws and regulations that could lead to declines in business confidence and negatively impact economic growth. Fortunately, there are a variety of protections from that outcome. First, the US does not have a history of making changes that drastically alter the structure of our economy and making any drastic changes is challenging. Our institutions, with their checks and balances, have generally protected our economy from drastic changes. A narrative that involves any one president drastically overhauling our economy also probably overestimates the power of the Presidency. The most fertile environment for sweeping regulatory changes would be when a single party controls both chambers of Congress and the Presidency. If this party was united around objectives that involved radical changes to economic policy, it could theoretically enact them relatively quickly. Fortunately, this is a rare event historically and a very unlikely outcome in our next election cycle, regardless of who wins the Presidency.
Even if drastic changes are pursued, there are further protections. First, the American political process is not immediate and that can be a boon for economic stability and provide businesses time to adapt. Also, there are courts that allow laws to be challenged and clarified. Finally, in cases were rules and regulations do change, businesses have a history of being flexible and tend to adapt well to changing rules and environments. The entrepreneurial spirit and innovative capabilities of American businesses should not be underestimated. I believe that a significant part of the economic stability across different political environments throughout history can be attributed to this innovation and creativity.
So, we do not expect any specific election outcome to result in a market catastrophe, but what about general uncertainty and volatility surrounding elections? Would it be smarter to sell investments now and wait for a more stable environment in the future? The short answer is no. One reason is that there is no pattern of excess volatility around elections in the past. Vanguard measured volatility surrounding elections since 1964 and found that the volatility of the S&P 500 has measured 13.8% in the 100 days before an election and 13.8% in the 100 days following an election and this is actually lower than the 15.7% average volatility over the entire time period. In addition to seeing average levels of volatility, election years also see average levels of investment returns. In the last 13 election years, the average S&P 500 return has been 10.6%, which is not statistically different than a non-election year. Markets already seem to understand the minor role that presidents play in economic growth.
Our political viewpoints can be biased and lead to costly mistakes when investing in markets that are purely by facts surrounding corporate earnings and economic growth. To illustrate how our views can alter our perspective, consider that during Obama’s Presidency from 2009 to 2016, roughly 25% of surveyed Democrats rated national economic conditions positively while only 10% to 15% of Republicans said the same. Through this period, the S&P 500 appreciated 194% cumulatively. When Trump was elected in 2016, those roles were reversed. Through the global economic shock of COVID-19, Trump’s term had coincided with the S&P 500 appreciating 68% (through August ’20). Despite this, only 30% of Democrats rated economic conditions positively while nearly 80% of Republicans said the same. An attempt to align a portfolio on partisan lines would have been a costly mistake in either case.
There are many reasons to concern yourself with the election, to do your homework and to VOTE. If you are investor, then any volatility experienced in the short term is to be expected. The best course of action as is to not alter your allocation. Stay invested in a balanced and diversified portfolio with a risk level that is matched to your objectives and risk tolerance. Yes, stay calm and carry on.
The information provided is general in nature, educational and is not intended as either tax or legal advice. Consult your personal tax and/or legal advisor for specific information. Covenant Trust is incorporated in the State of Illinois and is supervised by the Illinois Department of Financial and Professional Regulation. Covenant Trust accounts are not federally insured by any government agency. clients may lose principal as a result of investment losses.