US Presidential Election – Does it matter to markets?

28 August 2020

“Bad officials are elected by good citizens who do not vote.”
George Jean Nathan

While COVID-19 has been dominating the news cycle, the US presidential election is a mere two months away and we can expect it to return to the spotlight soon. After all, this election will determine the president of the largest economy in the world!

Investment management firms and banks have already begun offering their predictions on which candidate will be victorious. They have no shortage of theories about how each outcome would affect different market sectors and other world economies, and have been leveraging on the election to sell their thematic investments. By dangling the opportunity to make more money or avoid losing some, they hope to lure you or scare you into changing your market positions and engaging in further transactions with them.

As with most short-term predictions, however, such forecasts are inherently dubious. You’ll effectively be betting on the outcome of the US election, as well as how markets will react to those wins. What are the chances you’ll be right on both counts? This is gambling, not proper investing. Instead, investors would do well to look to history for some guidance.

It was only four years ago that the US held its last presidential election. Market strategists and chief investment officers (CIOs) all over the world were unanimous in their claim that Trump would be a disaster for markets while Clinton would be good.

The chart below, with predictions from major financial institutions, provides a refresher of what actually happened. It uses the ACWI ETF (All Country World Index) as the proxy for global stocks, and proves that basing investment decisions on forecasting – even from such reputable institutions – gives you a low probability of success.

What about the different political parties in the US? The popular belief is that Republicans are more business-friendly, and as such would be good for stock markets – and vice versa for Democrats. However, long-term research reveals no statistical difference in market returns regardless of whether a Republican or Democratic president was elected. Electing a Democratic president saw an average annual compound return of 8.4%, with a comparable 8.2% for a Republican president. Surprised?

More granular market information also shows no discernible difference to returns while either a Republican or Democratic president was in office. The diagram below shows US market returns during the terms of past US presidents.

You might believe that the US President’s foreign policy might affect international stocks, such as with Trump stoking China-US tensions. If so, you would also be on the wrong path. The diagrams below displaying returns during the terms of past US presidents show no difference on both international and emerging market stocks. (Note – EAFE: 21 developed market countries around the world.)

Another common theme is the belief that volatility and turbulence will strike markets during the election period. Investors hoping to escape that may be looking to sell to cash or hide in “safe haven assets” such as bonds or gold.

Interestingly enough, the data shows the opposite effect. Equity volatility was modestly lower in the weeks leading up to and following a presidential election than over a full market period. The results are not statistically significant, but counter-intuitive all the same!

In the end, investors should always be aware that investment themes and predictions rarely pan out the way we expect them to. The COVID-19 sell-off was a stark example of how markets can rally despite the economy being in the midst of a terrible slump.

It could be devastating to your investments if you lost sight of your long-term goals and strategies just to trade on an emotional whim. Remember: markets are affected by thousands of different variables. Politics are but a small component of the overall picture, and as you can see from the evidence above, it rarely pays to base your trades on a single election.


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GYC Perspectives

Markets are often irrational. Even among experts, forecasting does not consistently work. We instead believe in Evidence-Based Investing (EBI), which uses decades of empirical data and the greatest ideas in financial science to optimise investment outcomes. No market predictions, no forecasts, no emotions. All those things rely on gut-feel and intuition that cannot be consistently replicated.

Here, we share with you the evidence on why EBI works and why forecasting doesn't, as well as articles on topics such as behavioural finance to help you become better investors. New here? You can start with this introduction to EBI. Happy reading!

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