Fasten Your Seat Belts: Markets Could Have A Bumpy Election Season
With the Democratic and Republican political conventions behind us, election season is in full swing. This month seems like a good time to review the historical patterns of previous presidential elections and how investors can use that knowledge to guide them during the current season.
The U.S. stock market hates uncertainty. That’s why, as we can see in the graph below, the market has tended to sell off somewhat in September and October going into a presidential election. Once the outcome of the election is known, regardless of the winning party, the market ends the year on a high note, rallying in November and December.
Regardless of the current polls, I expect it will be a close election in November. And given the likely large number of mail-in ballots, it’s very possible that we will still not know the winner of the presidency the morning after Election Day. This uncertainty poses a risk for the stock market, and I think there is a high probability that this year will follow precedent with another weak September and October.
Market Performance in Election Season
The charts below show, by month, average market and sector performance for all years, 1970 to present, as well as the fourth year of the presidential cycle, the election year. Historically, the DJIA and NASDAQ experience losses in September and the S&P 500 has a slight gain. In October, all three indices normally have losses. After the election in November, the S&P 500 and DJIA begin to rise as the uncertainty fades, but the Nasdaq NDAQ has another month of losses before turning positive in December.
Only two sectors have positive returns on average in October of an election year: Retail and Technology. Given the extreme outperformance of both sectors this year, it will be interesting to see if this pattern holds. Coming out of the election, Health Care tends to perform strongly. In November and December, the Cyclical and Commodity sectors perk up as they look ahead to the new year with optimism, while Retail and Technology lag.
When an incumbent wins a second term, regardless of party, the market usually performs better in the first year of the second term than it does in the first year of a new president, as the chart below shows. This may be because, when the incumbent wins, it’s often because the U.S. economy is strong. Given the current economic weakness in the wake of the COVID-19 pandemic, I’m not sure if we can expect this to hold true if President Trump is re-elected.
The market also prefers a system of checks and balances, where one party occupies the executive branch and the other party controls at least one house of Congress. When the U.S. government is dominated by one party, one-month and three-month returns have generally been negative, regardless of whether the Republicans or Democrats are in charge. Over six months, market performance is flat under Democratic control and sharply negative under Republican. However, one year out from the ruling party’s election, returns are positive under both parties.
Light at the End of the Tunnel
History tells us that investors should exercise some caution in the waning days of summer and through September and October. After the election, the U.S. market has performed well on average, regardless of which party wins, though incumbents have better returns in their first year than new presidents. But given that markets have thrown off all semblance of normal seasonal patterns this year due to the extraordinary circumstances of the pandemic, 2021 could surprise us. Either way, I encourage investors to fasten their seat belts and reduce some of their risk as we enter what is likely to be a bumpy election season.
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