Does the U.S. election actually influence the markets?

An abrasive President, increasingly feisty opposition, social justice movements, police brutality, a pandemic and mass unemployment … it’s little wonder investors are eyeing the upcoming U.S. election with trepidation.

Whether the White House changes hands or the TV screen becomes a sea of red or blue, clients want to know how it will affect the market and their portfolio.

Kevin Headland, senior investment strategist at Manulife Investment Management, said investors should relax about the market consequences because history tells them to.

Speaking as part  of the Capital Markets Strategy team, he said: “While individual sectors could experience more ups and downs as a result of political party platforms, the overall market is less likely to be affected by legislation. Regardless of the way you cut up the various outcomes of the election, history shows that there isn’t that much difference in terms of performance.

“Ultimately, performance will be driven by the same factors as it is every other year: dividend yield, change in price-to-earnings ratio, and change in earnings growth. As always, we encourage investors to focus on the fundamentals, and nothing else matters.”

He added that elections, economic growth, and markets all move in cycles - sometimes they coincide and sometimes they don’t – and while government policies can have an impact on the economy and markets, it’s rarely immediate or profound. He stressed that economic growth is only one factor that tends to drive equity markets over time – the other being market fundamentals such as earnings growth and valuation.

The assumption is, however, that a Republican President will result in better stock market returns, as they’re believed to be more positive for Wall Street through policies that support higher earnings growth. However, Headland pointed to the performance of the S&P 500, including dividends, since 1945, which shows the opposite is true.

The stock market has returned 14.9% on an annualized basis with a Democratic president compared to 10.6% under a Republican president, although the results are skewed, as Republicans oversaw six of the worst calendar-year returns. George W. Bush, for example, had three of the worst calendar-year stock market returns as a result of the dot-com bubble and the Great Financial Crisis. The average return, from 1945 to 2019, was 12.6%.

Interestingly, markets are less enthusiastic in election years, with the S&P 500 Index posting an average return of 9.95%, including dividends, during a year in which Americans elect a President.

Headland said the years in which the incumbent was seeking re-election fared much better than years in which a new President must be elected — the difference between the two being an average gain of 14.30% for the former and 4.50% for the latter.

“The stronger-than-average stock market performance data in the final year of a first term may be the reason the sitting president almost always wins re-election,” he said. “On only two occasions since 1945 - excluding Lyndon B. Johnson and Gerald Ford - has a president not won re-election for a second four-year term.

“Rather than focus on 2020 returns, perhaps we should look at how markets react following elections. In the first year of a president’s term, the equity markets favour the incumbent political party over a change in the White House. If the ruling party maintained power, the first year of the new term returned an average of 15.4%. When there’s a change in party, the first-year average return for the S&P 500 Index drops to 5.7%. 

“However, when looking at the full four-year term, the returns are virtually the same regardless of political party — 13% and 12.6%, respectively. This would suggest that the first year of a party change is the worst year of the four.”