An election year is usually a significant one for financial markets, with added volatility and the suspense of which political party will come out the victor. Historical data shows that stocks generally enjoy a rally in the election season, but surprisingly don’t hinge on the outcome of any political party.
Despite the conventional thinking that Republicans are better for stocks with their pro-business policies, history shows that stocks actually perform better under Democratic leadership. Looking at the DJIA from 1900 onward reveals that stocks gained an average of 9% annually under Democrats, and only 6% under Republicans. However, accounting for normal variations in stock returns makes the difference negligible; so, in truth, neither party is particularly good or bad for the stock market.
The Election Cycle and the Stock Market Cycle
A Deutsche Bank research report from earlier this year shows there isn’t much evidence to support the idea that stocks perform better or worse in general during election years. Excluding the one-off recession in 2008, the data shows that during election years from 1960 to present, the S&P 500 saw average gains of 9.1%, compared to 8.8% for all other years.
Interestingly, the data shows a different story if you take into account only the years in which a new President is elected. Research at BMO Capital Markets, dating back to 1928, shows that during those particular years, the S&P 500 lost an average of 4%.
The data becomes even more telling when we look at who controls Congress during election years. In the same report, it shows that the S&P 500 gains on average 19.7% with Republicans in charge, compared to 7.2% with a split Congress. The gains are reduced to just 3.2%, during election years in which Democrats control Congress.
It tells us that the markets react more strongly to changes in the legislative branch of the government, rather than changes in the executive branch. But there’s a caveat to this data: gains during election years are always preceded by higher than average gains in the year prior. In other words, performance stems from economic activity, and is then filtered through politics to arrive at the ultimate result.
What Makes This Election Different
Annual U.S. GDP growth has been slowing with 3% for 2015 and an estimated 2.4% for 2016. Taking into consideration that stock gains during election years are primarily driven by economic activity, it seems safe to say that there isn’t much for the election to boost or diminish. There’s also the fact that the Fed has played a large part in how the markets have been performing lately. The environment of rising interest rates hasn’t been progressing as smoothly as investors had originally hoped, and that uncertainty is more on investors’ minds than the election.
While the broader indexes might not be largely affected by the presidential race, certain stock sectors like coal energy and healthcare could see wide swings, depending on who gets elected. Investors should keep in mind potentially politically affected stock sectors when picking stocks, but know that on the macroscopic scale, the markets will continue performing based on the economic data and not the presidential candidates.