How is Trump affecting volatility in the equity markets?

The US stock market in the sign of the presidential elections

Every four years, the US presidential election can have a major impact on politics, regulation, and economic and political relations. But how will the elections affect the US stock market?

The US elects its 46th President on November 3rd. Who will win? Another four years of Donald Trump? Or with Joe Biden a Democrat as the new president? A look back shows: In the race for the White House, history speaks for the incumbent president. Since 1932, almost three quarters of the incumbents have been re-elected.

Currently, the Democrat Biden is clearly in the lead in the national polls. He currently has a significantly larger lead on Trump than Hillary Clinton in the summer of 2016. If there were elections today, Biden would be the big favorite. Polls on the election of Congress are also currently favoring the Democrats. But there is still a long way to go until November 3rd. Elections and election campaigns are always in flux, with twists and turns even in normal times. It will therefore remain exciting, especially in an extraordinary year like 2020, in which the corona crisis hit the US economy hard. And last but not least: In 2016, the survey results were far off.

Recessions reduce the chances of voting

"It's the economy, stupid!" - With this campaign slogan, Bill Clinton won the US presidential election in 1992. The US economy has a major impact on the outcome of the presidential election. If the US economy went into recession a year or two before the election, the incumbent president was overwhelmed by the challenger. If there was no recession during the tenure, according to the US bank J.P. Morgan has been re-elected to all incumbent presidents since 1932. Viewed in this way, Trump's election prospects are permeated, especially since the crisis management of his administration was not convincing during the corona pandemic and the social unrest.

Nevertheless, the presidential race is probably not over yet. If the US economy continues to improve, a corona vaccine is on the way and the massive stimulus from the US government or the central bank continues to drive the financial markets higher, Trump's chances could improve. An economy that continues to struggle to emerge from the recession in late autumn and further losses in the stock market, however, would favor former Vice President Biden.

Volatile but good

Elections are always associated with uncertainties. New governments have new ideas that can affect employment, taxation, and regulation, among other things. As a rule, this also has consequences for corporate profits. Therefore, the volatility of the S&P 500 Index is higher in election years than in years without an election. There is a lot at stake for US companies in this year's election. A takeover of the Senate by the Democrats and a Biden victory could lead to an increase in the corporate tax rate from 21 to 28 percent. The earnings development of US companies would suffer as a result.

Past performance is not a guide to future market developments, but stock market historians regularly look back at stock market returns and try to spot patterns. How did the US stock market perform in election years?

Election years are mostly good years for investors

Typically, election years are good years for investors. The US stock markets have closed the election year with losses only four times since 1928. The US stock exchange is currently well on its way to ending the election year in the profit zone despite the corona crash. In the four-year election cycle, however, the third year on average is the best year on the stock market. There is also an explanation for this: In the third year of the election cycle, the US Federal Reserve tended to loosen monetary policy.

When a Republican won the presidential election, US markets tended to be more positive. Because the economic policy of the Republicans is generally considered to be more market-friendly. Judging by its performance from election day to the end of the year, the S&P 500 has also welcomed Democratic presidents in the recent past. The exception is 2008. But Barack Obama's election victory fell in the middle of the financial crisis.

The S&P 500 index in the context of the presidential election

Like the defaults, small cap stocks generally perform well in the weeks following the election. Small caps even tend to outperform large capitalization stocks. Given the higher beta of the small caps, it's not surprising that they should do slightly better in a stronger overall market.

Democratic presidents do better in the long run

Does the stock market do better for the full term if the US president is a Republican? No. A look back to 1929 shows that returns were more profitable under Democratic presidents.

The Dow Jones Industrial is doing well under Democratic presidents

The course pattern is streaked among Republican presidents

That stock returns were higher because a Democrat held the presidency is a misleading assumption. This is because stock markets are influenced by a variety of factors such as valuations, corporate earnings, business cycles, monetary policy, etc. In an increasingly globally networked economy, many external factors also play a role at the geopolitical and economic level, over which a US president has little or no influence at all.

Reliable election barometer

Investors often assume that the result of a presidential election suggests how the stock market will develop in the following year. More often, however, the stock market gives an indication of the outcome of an election. According to data from the US research company LPL Financial, the development of the S&P 500 in the three months leading up to the election often predicts whether the incumbent will be able to win re-election.

For example, since 1928 the stock market has predicted the winner of the presidential election 87 percent of the time, including every presidential election since 1984. If the S&P 500 rose in the three months leading up to the election, the incumbent party usually won; when stocks were weaker, the ruling party usually lost. In 2016, the stock market was the more reliable voting barometer than the poll results, which Hillary Clinton favored until recently. The S&P 500 fell 2.2 percent in the three months leading up to the election.

The study also shows that the US stock market tended to do the best in a divided convention. The average return per year for the S&P 500 in a split convention was 17.2 percent. However, if the Democrats controlled the House of Representatives and the Senate, the economy did the best with GDP growth of 3.3 percent per year.

The US stock market prefers a split congress (period 1950 to 2019)

Another rule of thumb is that US stocks perform better in a term in which Congress is dominated by one party and the presidency is assumed by the other. The basic idea is that this division creates a balance - and the markets like it. Do investors now have to worry if the Democrats should control Congress and the White House in the future? As the table below shows, such concerns seem unjustified.

When Democrats control the White House and Congress

Stay invested

And what conclusions should investors now draw from history? It is wise to keep an eye on the sectors that are most likely to be affected by the presidential election (such as healthcare or IT right now). But there is no need to panic about market volatility or the election result. Ultimately, one has to observe how politics will affect the domestic and global economies in the future. Because in the long term the economic development is more important for the stock markets. As in general, the same applies to the presidential election: a portfolio must always be well and broadly diversified, and investors should stick to a longer-term strategy that is designed for more than one election cycle. The best piece of advice is: stay invested.

Disclaimer:

This article does not constitute an offer or a solicitation to buy or sell investment instruments or transactions, but is purely descriptive and informative. Migros Bank does not guarantee the correctness or completeness of the information provided and does not accept any liability for any loss or damage of any kind that might arise through the use of this information.

Thomas Pentsy

Thomas Pentsy is a market analyst at Migros Bank. He gives tips on finances on the blog and analyzes current business developments.