Sensible Perspectives

Presidential elections, presidential terms and investment returns

Posted by on October 29, 2016

investment returnsThe US Presidential election is fast approaching. It is worth asking whether investment returns vary in predictable ways or are especially risky at such times. Perhaps we should be taking some action? One might imagine presidential elections to have both short-term and long-term effects on the stock market. The short-term effects would reflect the impact of the election itself. Long-term effects would represent the impact of presidential leadership throughout each president’s term. In the short term, there are two possibilities:

In the long term, there could be ongoing stock market effects of presidential leadership. Whether or not there is a discernable “election” effect, the market steadily (more or less) responds to the effective or ineffective leadership of the president.

As we begin this discussion, it’s important to acknowledge a number of significant difficulties:

What do the data say?

As far as short term effects are concerned, the authors are unable to identify many surprises. Only 4 of the elections in their sample were wrongly forecast by Gallup (the leading pollster of the period covered by the analysis), or with very close outcomes.

Of those 4, only Truman defeating Dewey[3] produced a large stock market move. The market declined roughly 10% between the day before the election and 20 days afterward. The chart[4] below also shows that the decline was about 5% from 40 days before the election to 20 days afterward.

sf-truman-dewey-chart

 

However, it’s hard to argue that the effect was either persistent or important. The red circle on the S&P 500 historical chart[5] below contains the period surrounding the Dewey / Truman election. The stock market was in a holding pattern for the first year of Truman’s term after the election, and then moved upward. Of course, some might suggest that it would have moved higher under Dewey, but as I indicated above, that’s an assertion that is impossible to test. In the scheme of things, not much to see here.sf-sp-500-chart

As far as the long run is concerned, Santa-Clara and Valkanov find that the stock market has performed substantially better under Democratic presidents than under Republicans (as in, 10% per year!). They look at three time periods (1927-1998, 1946-1998 and 1960-1998), and the finding holds in each one. The difference is statistically significant.

However, I must confess that I’m not persuaded.

The problem is not that the presidents had no influence on the stock market outcomes – I’m sure that to some extent they did. The problem is that major market movements (such as the market crashes in the Great Depression and Great Recession) have a disproportionate influence on the analysis, and I don’t believe that we can assign responsibility for those major movements to the president.

For example, starting in 1927 means blaming the Great Depression stock market crash (that’s an 82% decline in real terms) entirely on Herbert Hoover, a Republican, while Franklin Roosevelt, a Democrat, gets the recovery. Bill Clinton, a Democrat, gets credit for the Internet boom of the 1990s. While there is something to be said for the argument that Al Gore invented the Internet,[6] Clinton was president in the 1990s, not Gore.

If the analysis were extended to the present day from 1998, George W Bush (a Republican) would be responsible for the Great Recession, while Obama (a Democrat) would get the recovery. However, many of the seeds for the Great Recession were planted under Clinton and even before, and Bush (not Obama) appointed Ben Bernanke, the Fed Chair credited by many with masterminding the recovery.

In short, my sense is that the Santa-Clara and Valkanov results are more a matter of luck than causation – presidents have been present during stock market movements, but not responsible for them. Incidentally, when they expand the analysis to include the party in control of the House and the Senate, Santa-Clara and Valkanov are no longer able to attribute differences in stock market performance to the party of the president in power.

Anticipating stock market results either for the following four weeks or for the next four years based on who wins the election is thus not supported by the evidence, in my view.

So, what to do?

As I write (at 4 PM on Tuesday, October 18th), FiveThirtyEight (http://projects.fivethirtyeight.com/2016-election-forecast/national-polls/), which collects polling information from many reputable polling entities, shows Clinton with a 45.6% to 38.9% lead, and almost an 85% chance of winning the election.

You could think of FiveThirtyEight as producing a “meta-poll.” It summarizes the findings of many independent polling organizations, each with its own methodology and sample of respondents.

In a sense, the stock market is similar, collating information from a myriad of sources, and producing a single number incorporating the views of every market participant in proportion to share ownership. The stock market likely has “priced in” a high probability that Clinton will win – market participants effectively are probably summarizing the available polling information just as FiveThirtyEight has done. (The Irish bookmaker Paddy Power is already paying out on a Clinton victory.[7])

Thus, a Trump victory would qualify as a surprise.

To make an investment decision, we need to have strong beliefs about:

I’ll posit the beliefs one would need to make an investment decision about a Trump victory:

If one believed that the stock markets would recover in the longer run, then market timing would be required – sell now, before Trump wins, and buy back after the decline but before the recovery. One would have to be able to identify the turning point. Very difficult to do.

If one believed that the stock markets would continue to decline indefinitely after a Trump victory, there is still a timing problem – when to sell and when to buy back. One could sell now, and buy back if Clinton wins, accepting the loss of market exposure between now and the day after the election as a modest price to pay for safety. One could wait and see, and if Trump wins, sell immediately, accepting the significant loss one expects to occur in that event.

Then, one could continue to hold cash until either

  1. One knew that the bottom had arrived; or
  2. Until Trump’s successor is elected or takes power.

Choice a) again is a timing problem, choice b) works only if markets continue down throughout Trump’s entire term. The market is constantly forecasting the impact of news events on stock prices and on stock returns more broadly. To make money by trading in and out of the market, one must forecast those impacts before the market does and more accurately than the market does – a tall order.

Summing up:

  1. The evidence for presidential effects on stock market performance is weak at best.
  2. Even if one were confident that there would be a “Trump effect,” one would still have a significant market timing problem to solve.

Sensible Financial® is inclined to treat the possibility of a Trump victory no differently than we would almost any other news event. We believe that the stock market forecasts investment impacts of news events more accurately than individual people do, and that the durations and sizes of market responses to those forecasts are not predictable. We encourage our clients to manage the uncertainty of investment returns by diversifying their investments to limit exposure to individual securities and maintaining stock exposure at risk-affordable levels.

Nevertheless, we recognize that you may find the prospect of either a Trump or a Clinton victory to be very unsettling, and you may wish to adjust your investments accordingly. If so, please contact your advisor.

[1]Santa-Clara, P. and R. Valkanov, “The Presidential Puzzle: Political Cycles and the Stock Market.” The Journal of Finance, 2003. 58(5): p. 1841-1872.

[2]Ibbotson, R., et al., Stocks, Bonds, Bills, and Inflation 1992 Yearbook: Market Results for 1926-1991. 1992.

[3]https://en.wikipedia.org/wiki/Dewey_Defeats_Truman

[4]From Santa-Clara, P. and R. Valkanov, The Presidential Puzzle: Political Cycles and the Stock Market. The Journal of Finance, 2003. 58(5): p. 1841-1872.

[5]http://www.macrotrends.net/2324/sp-500-historical-chart-data

[6]https://en.wikipedia.org/wiki/Al_Gore_and_information_technology

[7]CBC News, October 19, 2016, http://www.cbc.ca/news/business/paddy-power-presidential-betting-1.3810006