Markets fall before close elections and rise after, study finds

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The stories that matter about money and politics in the race for the White House

With the US presidential election less than two months away and polls suggesting the two front-runners are neck and neck, it’s no surprise that some investors are getting nervous.

Research recently published by Research Affiliates, the research consultancy and investment advisor, revealed that these nerves are familiar and translate into predictable investor behavior.

The paper, written by Rob Arnott, president of Research Affiliates — which has made its name developing smart beta strategies that adjust broad market indices to emphasize factors such as value — and Forrest Henslee, vice president of research, shows that the political affiliation of the winning candidate in the US election had less influence on the markets than how close and contested the election was.

They looked at 24 US elections since 1928 and found that S&P 500 stocks tend to fall in the run-up to close elections, then rise in the final week of the campaign before continuing to rise, albeit with greater volatility , after – election day.

“We believe this is due to the fear that the result increases – on both sides of the aisle – before the election and then dissipates, on one side of the aisle,” the authors wrote.

They noted that after the election, differences between political outcomes could be observed. So, while in the lead-up to an election, growth and value stocks tend to perform similarly, after an election, value stocks tend to rebound when Republicans win the White House, while growth stocks tend to rebound when democrats take over.

Therefore, for short-term investors, Research Affiliates’ findings suggest that close monitoring of the election makes a lot of sense.

But there are other important messages from the researchers for investors with a longer-term view. Morningstar research published in June, for example, looked at S&P 500 returns over 50 years. It found that since 1953, $1,000 invested when a Democrat is president, sold when a Republican takes office, then reinvested when a Democrat returns turns into $62,000. The opposite strategy — investing only when a Republican sits in the Oval Office — only increases to $27,000. However, doing nothing and leaving the $1,000 where it was for that period would have netted investors $1.7 million by the end of 2023.

However, Arnott pointed out that Morningstar’s observations focused on the return of a four-year presidential term, while Research Affiliates focused on the six weeks before and after the election.

He also argued that while the long-term numbers suggest that a Democratic presidency is better than a Republican presidency for the stock market, those results are skewed by the Wall Street Crash of 1929 and the Great Depression that followed, and the financial crisis of 2008, which wiped out the Republicans’ notebooks. .

From 1860 to 1920, it was the other way around, he said.

“Our conclusion from the mixed results is that either side can pursue policies that enable prosperity; and either side may pursue policies that crush the initiative. But that was not the purpose of our paper, which focused on the weeks around the election,” Arnott said.

Research Affiliates’ work seems to confirm that we tend to act on our short-term intuitions. A Donald Trump victory, for example, has raised fears in some quarters that there could be significant consequences for electric vehicle manufacturers and the EV battery suppliers that power them.

However, even in trying to make sector decisions, investors could end up wrong. Financial Times columnist Stuart Kirk points out that while President Joe Biden, with his green spending and stimulus, might have been expected to have been bad for extractive industries, US oil and gas companies are the fourth largest domestic sector with the best performances during the Biden administration.

It might be wise, then, to ignore the news when checking your portfolio.

“In general, we would caution investors against trying to time the market based on political views or short-term patterns based on past elections,” said Andrew Prosser, head of investments at UK-based ETF investment platform InvestEngine.

“Market-timing, especially over such short periods, is a fool’s errand for investors because it has historically proven impossible to do successfully. Instead, investors should keep their eyes focused on the long term,” he added.