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How Do U.S. Presidential Elections Impact Stock Markets?

Historical data shows that there is a correlation between U.S. stock performance and presidential elections. But whether you want to act on this data is quite another matter.

Uncertainty over the outcome of American presidential elections has made for some fairly volatile U.S. stock markets over the last century or so.

But that likely doesn’t mean you should be making big defensive moves ahead of the contest that happens every four years.

Equity markets are amazingly resilient and can cope with a variety of bad news. As long as an event can be ‘priced-in’, investors will remain relatively sanguine.

Uncertainty is a different matter – it’s hard to pin a price on something that just won’t stop moving around. It’s the sort of condition that can make investors hit the sell button and just wait for things to settle down.

There’s been plenty of it in the eighth year of an incumbent’s term. On average, according to the Stock Trader’s Almanac, the benchmark S&P 500 index has fallen on average 1.2 per cent in that final year since 1900.

Uncertainty is the driver here, as the data do not favour either Republicans or Democrats. No matter how you felt about the previous administration, at least you had a fairly decent idea where it was going. That’s not the case with a new face, whether that person is Democrat or Republican. What it comes down to is that the incumbent is out of the running.

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Some years have seen a far more dramatic decline. The biggest drop was in 2008, the final year of George W. Bush’s second term, when the S&P 500 plunged close to 41 per cent as the financial crisis roiled markets across the globe.

Not that every year has been in the negative column. The Stock Trader’s Almanac also notes that the S&P 500 has actually experienced growth in 44 per cent of those years from the start of the 20th century.

That mixed showing tends to make investing professionals leery of acting on such data.

“That’s not much of a bias one way or the other to bank a lot on,” observed Julie Brough, vice-president and portfolio manager at Logan Wealth Management in Toronto.

“You want to have pretty convincing data to back it up and this is a skewed view. And I’m not willing to bet my clients’ success on something that subtle.”

Still, the data provides an interesting historical snapshot on how markets have reacted to presidential contests.

For example, the S&P 500 has advanced by an average of 11.5 per cent in year four of the first term of a U.S. president. That’s partly due to the fact that the chief executive has racked up some sort of a record of performance over the previous four years, he/she is a known commodity and the president stands a good historical chance of getting re-elected.

“I believe there is a bit of a bias probably at that point in the cycle because we know what they do, they come into their term, they do the ugly stuff, get it out of the way so they can do all the happy things coming toward the end of the term in a bid for re-election,” added Brough.

At the same time, the new occupant of the Oval Office is a largely-unknown quantity. This is reflected in other data showing the first year is the weakest of the four as the new president firmly puts his or her stamp on the government. And that stamp has been known to be at odds to what was said during the heat of the election campaign.

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But the important takeaway from this data is that investors shouldn’t be spooked into doing something that smacks of market timing. In this instance, the old saw applies – you have nothing to really worry about as long as your portfolio in American equities is properly diversified.

“It’s important to understand the underlying aspects of your portfolio, not just the headline risk because if you understand that, then you can make rational decisions,” said Brough.

“Understanding what the real risks are to your portfolio, what the exposures are, (is) how you manage the risk of these things and making sure your portfolio isn’t geared to potentially one event.”

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