You, the Stock Market, and Your Election Fears

Presidential party affiliation does not matter when it comes to the stock market.

Presidential party affiliation does not matter when it comes to long-term stock market performance.

This perhaps provocative notion was advanced in the Dimensional Funds Advisors article below. They wrote, “….over the long run, the market has provided substantial returns regardless of who controlled the executive branch.” Part of Dimensional’s proof is a graph showing the growth a dollar invested in the S&P 500 index since 1926. Investment growth under Democrats is highlighted in blue and Republicans in red. Some may argue that performance is better under Democrats. We know that performance under a couple of Republican Presidents was poor. But under Democrat Presidents, better performance coincided with periods of more volatility or risk. Investors expect greater rewards for greater risk, so better performance should be expected. This is what the Federal Reserve Board staff working paper, “Alternative Estimates of the Presidential Premium,” found. After adjusting for risk, the authors concluded: “the apparent discrepancy between the stock market performance of Democrats and Republicans is largely reduced.”

The stock market quickly absorbs Presidential election (and all other) news.

This helps explain the disconnect between party affiliation and stock market growth. Traders quickly bid stocks up or down on perceived probabilities of policy changes before a new administration even takes office. As an example, Economics Professor, Justin Wolfers, contrasted Secretary Clinton’s chances of becoming President to the prices of overnight stock market futures during the first debate in Debate Night Message: The Markets Are Afraid of Donald Trump. The professor argued for that particular time period, markets rose as traders perceived that Secretary Clinton’s odds of winning were increasing. By the time you’re aware of news affecting stocks, caffeinated traders know it and have already incorporated the news into existing prices.

Trading in anticipation of an election outcome is a bad idea.

There is a myriad of other factors affecting stocks, both political and economic. In the political realm, for example, after the first debate, the Wall Street Journal later reported odds increased that Republicans might lose the House in Investors See New Risk in Trump Swoon: A Democratic Congress. The article noted the potential negative impact of likely Clinton policies on banks and pharmaceutical stocks. Predicting these outcomes is market timing, but successful market timing is difficult as we have discussed here and here.

Rather than trying to outguess market reaction based on potential election developments over which we have no control,we recommend investing based on what the investor can control:

1. An investment strategy aligned with your willingness, need, and ability to take risk. This will serve you well no matter who becomes President.
2. The extent to which you diversify globally. Sometimes the unexpected occurs (think Britain’s exit from the European Union). Diversified holdings dampen market risk. For more background, see International Stock Allocation: 0%, 20%, 50%, or None of the Above?
3. Exposure to factors driving long-term stock market performance. Among these factors are company size, relative price or value, profitability, and momentum. Each has strong academic evidence behind them. To gain exposure we recommend funds from Dimensional Funds Advisors, AQR, Vanguard and selected ETF’s.

If the election is getting you down, let us know. We’ll be happy to talk about a sensible financial and investment strategy to meet your personal goals.

Most investment activity is a lot of churning that leads nowhere. This is why it is vital to know what strategy you are following and to understand it well enough to be strapped in. — Phil DeMuth, The Affluent Investor.

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This blog entry is distributed for educational purposes and should not be considered investment, financial, or tax advice. Investment decisions should be based on your personal financial situation. Statements of future expectations, estimates or projections, and other forward-looking statements are based on available information believed to be reliable, but the accuracy of such information cannot be guaranteed. These statements are based on assumptions that may involve known and unknown risks and uncertainties. Past performance is not indicative of future results and no representation is made that any stated results will be replicated. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Copyright © 2016, Granite Hill Capital Management, LLC.

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