Keep Your Politics & Your Investments Separate – Here’s Why

…Market-related predictions have become a quadrennial tradition, but that doesn’t mean that they’re worth the ink that’s spilled on them. In terms of broader trends, politics in general – and elections in particular – have minimal predictive value with respect to subsequent market (and economic) activity. Nonetheless, we’ll take some time to consider what both the historical – and the more recent data might be telling us about this year’s election.

The comments above and below are excerpts from an article by Evan Powers (myFinancialAnswers.com) which may have been enhanced – edited ([ ]) and abridged (…) – by  munKNEE.com (Your Key to Making Money!)  to provide you with a faster & easier read.  Register to receive our bi-weekly Market Intelligence Report newsletter (see sample here , sign up in top right hand corner.)

The historical data

As a general rule, the impact of presidential elections on market outcomes is statistically weak and unreliable, in large part…[due to the] small sample sizes: Since there is only one election every four years, we only have a couple of dozen useful data points to draw from, many of which are so old as to make extrapolation to the current environment problematic…

Nevertheless, if you study a data set long enough, a few trends are bound to pop out. One of the most commonly cited effects is the “previous 3 months” phenomenon. Over the last 22 elections, the direction of the stock market in the 3 months leading up to the election has correctly “predicted” the winner 19 times: When the market is positive in the pre-election period, the incumbent party tends to hold onto the White House; when the market is negative, the incumbent party loses. The three exceptions occurred in 1956, 1968, and 1980 – interestingly, all Republican wins. Of course, that phenomenon says nothing about subsequent market returns. If anything, the effect suggests that the stock market impacts the election, and not the other way around.

What happens…if we do attempt to study subsequent returns? [Well,] since the 1952 presidential election (we’re studying only the time period for which S&P 500 data is most reliable), 10 out of 16 elections have included a sitting president; of those 10, the incumbent president won re-election 7 times. In the 6 elections without a sitting president, the incumbent party only held onto the White House once. That last fact alone makes drawing historical conclusions about the election’s impact on the stock market difficult, because one data point cannot be trusted to indicate a trend.

That said, in the 8 elections where the incumbent party kept the presidency (7 of which were, of course, reelections of sitting presidents), the 12 months following Election Day saw an average gain of 10.88% but, when the incumbent party lost, the market was essentially flat over the next 12 months, with an average return of -0.23%. That difference may or may not indicate a causal link, but it would lend credence to the theory that markets dislike uncertainty, and therefore, perform best when there is a sense of continuity in the White House.

For what it’s worth, the one election in which the incumbent party held on to the presidency despite the absence of a sitting president (1988, George H.W. Bush over Michael Dukakis) saw one of the strongest subsequent rallies in our data set, with a 22.9% gain. That fact might get Clinton supporters excited, but remember, the predictive power of a single data point is minimal.

This year’s data

…By any reasonable quantitative definition, there is no meaningful relationship between election odds and stock market activity…[as the chart below clearly illustrates]:

…The data…notwithstanding, many voters remain convinced that the election outcome is pivotal. A recent CNBC poll found that 53% of those surveyed thought Clinton would be better for markets than Trump, while 26% thought Trump would yield higher returns (the remaining 21% were apparently either neutral or had no opinion).

Ultimately, we can slice and dice the data any number of ways and reach a variety of different (and likely contradictory) conclusions about how the election might impact markets but recent experience suggests that the market has a tendency to overreact to political news, both in magnitude and velocity. Furthermore, the election itself is but one data point in a sea of political data. Remember, we’ve said nothing here about the control of the House and Senate, the status of monetary policy, or anything whatsoever about international economic influences (think: China).

In Conclusion

In the final analysis, it’s generally best to leave politics out of your investment approach. More often than not, meaningful political change takes years to develop, and for the impacts of those changes to flow through to the broader economy. Even then, the market may respond to those changes in ways we didn’t anticipate…

We don’t know how this election will turn out, nor do we know with any certainty how the market will respond to the variety of different potential outcomes. What we do know is that having a coherent plan in place (and sticking to it) yields positive risk-adjusted returns over the long run. Don’t get caught overreacting with the crowd; remain flexible and nimble, take advantage of others’ lack of preparation, and you’ll almost always come out ahead.

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