Presidential Election and Your Asset Allocation
With the election less than a month away, we are seeing much speculation about what investors should do. In response, we have spent time reviewing a lot of research and commentary on elections and markets and wanted to provide commentary on our review of some historical and current data. We hope you find this interesting (and potentially calming). Here are some “factoids” to keep in mind as we go through this season:
The market has rewarded investors who remained invested. If your investment horizon extended beyond 10 years – which is most investors - you have been rewarded well for remaining in the market. For those with shorter-term horizons, market exposure should be more limited.
Since 1929, in only 4 out of 23 presidential 4-year terms has the market had net negative returns. Said more optimistically, 83% of the time, markets have gone up during a president’s term – whether Republican or Democrat.
We have market corrections. They come and they go, and how soon we forget. There have been 24 corrections (when the market drops 10-20%) in the S&P 500 since 1974, including this February/March. Markets go up and down at times. We press on and have been rewarded for doing so.
Presently, implied risk around the election is high as indicated by the future contract prices on risk indexes. People are nervous, but this also looks like a short-term (e.g. Nov/Dec) phenomenon. Once again, keep your perspective on the right timeline.
Politics Actually Have Little Impact on Markets Over Longer-Term
Since 1926, U.S. markets have rewarded investors with attractive long-term returns. It has not always been a straight line up, but over longer-term, returns have been positive. In fact, only 6 of the 85 10-year periods have had negative returns, and 4 of those were in the 1930s. Looking across Presidents and Political parties, you see a fairly consistent pattern of 4-year positive regardless of who sits in the White House. It is important to keep time horizons in mind and have patience.
Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Source: S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. Source: S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
Markets Don't Seem to Care Which Party is in Office
This is a powerful chart that we found. What if you only invested when your preferred party held the Presidency? While we doubt anyone would implement this strategy in their portfolio, this once again shows the power of staying invested regardless of who is in political power. In fact, trying to go in and out of the market based on your politics could be very detrimental to your wealth!
Haver, Invesco. As of 6/30/20. For illustrative purposes only. It is not possible to invest directly in an index, and these hypothetical returns are not meant to imply the expected returns for an individual investor. Past performance is no guarantee of future results.
Is There a "Winning" Presidency/House Leadership Model?
Final “political” chart. Does it matter if you have a mixed presidency and house or one-party rule? Surprisingly, not really.
This analysis looks at cumulative returns under different party leadership models (e.g. who controls House and Presidency). As you can see, there isn’t much difference in the cumulative returns over those periods. We may think there is - or even hope there to make our political point - but the data tells a different story. (And one that once again reminds us to stay invested.)
Risk Around The Election
If you are feeling nervous, you are not the only one. The price of “insuring against volatility” around the election is nearing record highs as futures contracts priced against the CBOE Volatility Index (VIX) - which measures expected volatility over the coming 30 days for the S&P500 - are requiring significant premiums.
Yet, the premium being paid for these contracts declines rapidly post-election. This isn’t necessarily predictive, but it does indicate that people are anxious about the uncertainty of events around the election. But it also indicates that this anxiety abates in the following months.
VIXCentral.com; www.marketwatch.com Betting against election volatility draws contrarian investors as market swings forecast not violent as feared. Last Updated: Sept. 28, 2020 at 10:04 a.m. ET.
Market Corrections Come and Go
What if there is a correction?
Since 1974, there have been 24 market corrections (10% - 20% decline from peak) with only 5 becoming bear markets (20+% decline from peak). Corrections do happen. Yet, markets reward investors who patiently persevered (see previous slides). But these investors didn’t have to be patient forever. In fact, the average duration of a correction has been roughly 15 months. So unless you have a short-term horizon, the correction will soon be left behind (like in December 2018 or February 2020). Investors can never be sure when corrections will come but knowing that they will come, investors can instead view them as opportunities to rebalance and tax-manage their portfolios.
Schwab Center for Financial Research with data provided by Morningstar, Inc. Each period listed represents the beginning month/year of either a market correction or a bear market. The general definition of a market correction is a market decline that is more than 10%, but less than 20%. A bear market is usually defined as a decline of 20% or greater. The market is represented by the S&P 500 index. Past performance is no guarantee of future results.
Closing Thoughts
How can it be that politics doesn’t seem to matter to the markets? We know political parties have different views on taxes, economic stimulus, big vs. small government, international trade policies, etc. Yet, the data says this doesn’t seem to matter. Here are some possible explanations that we have heard:
The markets take a longer-term view than 4-year or even 8-year terms. The price of a stock reflects the present value of all future cash flows, which in most cases is well beyond the current president’s term.
The US economy is a difficult ship to steer and changes course very slowly. Data shows that the big policies trumpeted by each party as they get into office don’t actually activate as much change as expected over the long run. There are legal challenges, political changes (e.g. mid-term elections), and public polls that tend to moderate changes. This is actually a strength for our country.
The current prices in the market already reflect expected outcomes and the risks of uncertainty. The market continuously places odds on who will win and the economic effects of them winning, and the uncertainty of outcomes. That’s why in most cases, 3 - 6 months after an election, markets are up – no matter who wins. Uncertainty pushes prices down. Certainty (with any political party) seems to push prices up.
We have an increasingly more global economy that impacts business. While we focus on US politics, global politics are also at play and tend to dampen impact to the U.S. This is also why global diversification is important.
So, unless you have a very short-term horizon, we tend to remain invested in global equities, keeping clients diversified and using any corrections as opportunities for rebalancing and tax management.
