“Surely the stock market will tank if ________ becomes the next president?!”
Regardless of which candidate you might place in that blank, both the historical evidence and investment theory suggest that election results are a poor guide for investment decisions. For example, as illustrated by the chart below from Dimensional Fund Advisors, stocks have tended to post gains under both Democratic and Republican administrations.
Source: Dimensional Fund Advisors, “Bulls, Bears, and Ballots: When Looking at Politics and Markets, Think Long Term,” https://www.dimensional.com/us-en/insights/bulls-bears-and-ballots-when-looking-at-politics-and-markets-think-long-term
In the modern political era (post-WWII), the S&P 500 has averaged 14% annualized gains under Democratic administrations and 10% annualized gains under Republican administrations. Based on history, markets during Democratic presidencies have fared better. (Or been luckier! See below.) But two observations may render that arithmetic moot:
- There have only been 14 presidential administrations in the modern era. This is too low a sample size to draw any firm conclusions about the relative effect of political party on the stock market.
- Even if we had reason to believe markets during Democratic administrations produce better relative returns than during Republican presidencies, that still would not suggest a stock market timing strategy! After all, what is statistically significant is the historical outperformance of stocks vs. less-risky asset classes (e.g., cash or bonds), regardless of which party is in the White House!
This is exactly what we would expect. After all, the stock market allows us to invest in potentially thousands of companies, not political parties— with executives and employees who are constantly working to remain innovative, competitive, and profitable…regardless of the political backdrop. And stock prices are set by the classic “wisdom of the crowds”—representing the aggregate brilliance of many great minds, massive supercomputers, researchers with in-depth analyses (now backed by powerful AI), and millions of participants that collectively constitute “the market.”
This hive mind is aware that an election is coming! And while it doesn’t know the outcome, it has marched upward this year, nonetheless. This is because the occupant of the White House is just one of many variables that affect the economy and the stock market. The market peers into the deep future, projects out expected corporate cash flows across all those years, and then discounts them back to a current price via a discount rate (the market’s “expected return”) high enough to justify the risk that future cash flows may underperform expectations. The election is just one of a near infinite number of data points that affect those calculations.
As always, we fall back on fundamental principles of stock market investing:
- The stock market is always priced for a long-term positive expected return above those of less-risky investments.
- The stock market is always risky, such that it may underperform less-risky investments instead.
- The equity “risk premium” can and will vary, and ex post can be negative.
If your financial plan would be devastated by a bear market, then you should probably reduce your holdings of stocks…not because the election is a particularly scary time to invest, but because your risk exposure is too high. But if you have the capacity to take the risk, the potential rewards are tremendous for investors who can stay in their seats through the endless parade of reasons to worry, elections included.
1 If we examine the entire 97-year history of the S&P 500 Index, the outlier event of the Great Depression drives a wider wedge between the average returns under Democratic and Republican administrations and expands the sample count from 14 to 17. However, the above observations still hold, including the lack of statistical significance, as the results are still insufficient to reject the hypothesis that the average returns are the same between the two parties.