The US election will have a major impact on the country's direction for years to come. They affect everything from the economy and fiscal policy to trade relations and domestic spending.
But do elections affect the stock market? If so, is it good or bad for the market?
In this guide, we'll look at data on the presidential and midterm elections to answer these questions and help investors and traders navigate the upcoming elections.
Do elections affect the stock market?
We will look at both presidential and presidential elections to assess their impact on the stock market.
An analysis by a US bank comparing stock market returns and elections going back to 1932 found that in the year before a presidential election, the stock market tends to underperform.
In any 12-month period not before a presidential election, the market has gained an average of 8.5%.. But in the 12 months immediately preceding the election, the market gained an average of only 6%.
Bonds also suffered in the run-up to the election, the analysis found. Bonds rose 7.5% in any non-election twelve-month period, but rose only 5% in the twelve months leading up to the election.
U.S. Bank also analyzed stock performance over the midterm election period dating back to 1962. This analysis found that In the 12 months leading up to the midterm elections, the S&P 500 rose an average of just 0.3% compared to a 60-year average annual gain of 8.1%.. In the 12 months immediately following the midterm elections, the market gained an average of 16.3%.
This suggests that the market tends to underperform severely in intermediate years and outperform the following year.
However, a long-term Vanguard analysis looking at returns dating back to 1860 found that there was almost no difference in the performance of stocks and bonds between elections (including midterms and presidential elections) and non-election years. Vanguard's analysis found that a typical portfolio of 60% stocks and 40% bonds would have returned 8.1% on average in election years and 8.2% on average in non-election years.
Political parties and stock market performance
Interestingly, analyzes by both U.S. Bank and Vanguard found that election results—which political party won—have almost no effect on stock market performance.
For presidential elections, if the White House switches parties, the stock market gains average 5% over the following 12 months. If the incumbent party is re-elected, gains average 6.5% over the following twelve months. There was no difference based on whether Democrats or Republicans held the presidency.
For the midterm elections, there was no statistically significant difference in stock market returns in the 12 months following the election, regardless of whether control of Congress changed or the incumbent party remained in power. There was also no difference based on whether Republicans or Democrats controlled Congress.
Presidential elections and fluctuations
An analysis by Hamilton Place Strategies found that implied volatility, as measured by the VIX, increased consistently in the run-up to the election dating back to 1992. However, the same analysis found that there was no trend in realized volatility in the S&P 500 after that. Election result.
Moreover, Vanguard's analysis found that annualized volatility in the S&P 500 was the same, at 13.8%, for the 100 days before and 100 days after the presidential election.
This suggests that elections do not provide great opportunities for trading. However, analysis of Hamilton Place Strategies has found that candidates' policies can lead to significant spikes in volatility in individual stocks. In 2016, for example, when Donald Trump won the presidency in a surprise victory, oil and gas stocks saw a huge spike in volatility.
Long-term investing around elections
For long-term investors, these results suggest that the 12 months before an election—whether a presidential election or a midterm election—tend to see worse stock market performance than the 12 months after an election.
However, it is important to note that in most election years, the S&P 500 still delivers positive performance. This means that investors will ultimately miss out on gains by waiting for a non-election year to invest.
So, long-term investors shouldn't pay much attention to election cycles. They may want to weight their investments slightly in non-election years, but it is not advisable to postpone investing entirely during election years.
Investors should also keep in mind that elections can have a psychological impact that they must take into account. If an investor's preferred party loses on election night, this may encourage them to withdraw from the market. This can ultimately hurt investors' performance because they can miss the first days after the election, when volatility declines and a potentially superior non-election year begins.
Short term trading around elections
Short-term traders can try to trade around elections, but the data suggests that elections generally do not lead to increased volatility in the stock market. The best approach for traders may be to focus on stocks in industries whose fortunes depend on election results.
For example, in an anticipated rematch between Biden and Trump in 2024, renewable energy stocks and oil and gas stocks could see high volatility if Trump wins. However, there is also the possibility that the election results will be priced in for these stocks if the outcome is correctly predicted before election night.
Conclusion: Elections and the Stock Market
Historical data shows that the stock market tends to underperform in the 12 months leading up to presidential and presidential elections. However, the market has historically outperformed its long-term average in the year following midterm elections. Stocks typically aren't much affected by which party wins or whether control of the White House or Congress changes hands.
Investors may consider investing more heavily in the market in non-election years, but on average they will receive the highest returns by investing consistently and staying invested regardless of the election outcome. Traders are unlikely to find unusually high volatility around a presidential election, although they may be able to act on volatility in specific stocks affected by the candidate's proposed policies.