Time to Read: 7 Minutes
2020 has been a wild year so far—an unprecedented year, you could even say, as many memes do. And yet, another major event looms on the horizon: the presidential election, set against a backdrop of recession, global pandemic and social unrest. Here we consider how markets have behaved through various historical election scenarios and also share our current portfolio positioning.
Historical market performance around elections
The perennially relevant chart below shows the market’s tendency to perform better when the incumbent party wins than when it loses. These trends have been amplified under Republicans, with the strongest gains coming when incumbent Republicans have won and the biggest losses when incumbent Republicans have lost, on average.
It should be noted that there are not a lot of cases in the sample size and this could be just a coincidence related to economic performance at the time of the election. The economy is integral to both the election and the stock market. Does the market decline because of a recession, causing the incumbent party to suffer? Or is the incumbent president penalized for his weak economic performance, and the markets reflect the uncertainty? The answer is probably some of both. Since Republicans have often positioned themselves as the pro-business party, it stands to reason that the market has been more sensitive to their reelection chances.
The chart below shows how relative performance has reversed in post-election years, with the strongest average gain in years following incumbent Republican losses. As such, if Donald Trump loses the election and markets drop, following their historical tendencies, this might be viewed as a buying opportunity.
Assessing the interaction between the economy, market and election results
The Trump administration has long touted the ‘greatness’ of the American economy under its leadership. That was all thrown out the window when the pandemic arrived, triggering the fastest decline into a recession on record. Ned Davis Research has illustrated that, when the economy is in a recession on election day, the incumbent party has lost 80% of the time, versus losing 32% of instances when the economy was in expansion. While most economists expect the recession to be over by November—and here at BWM, we believe it has already ended—the main question for candidates is not whether the official economic pundits declare that a recession has ended, but how voters feel about the economy.
Since 1900, the incumbent party has won three times and lost eight when there was a 20% decline in the Dow Jones Industrial Average (DJIA) or a recession in the election year, as shown below. The last incidence was Truman in 1948. Since 1952, no party has retained the White House when there was either a 20% market decline or a recession; both have taken place in 2020.
What about a Democratic sweep?
Based on client questions, a chief concern is what would happen if the Democrats win the presidency and a majority in both houses of Congress. A Democratic sweep could increase the risk for more regulations and taxes, thereby increasing uncertainty, which the market hates.
The chart below illustrates the concern. It shows inflation-adjusted returns for the DJIA based on the combination of presidential and congressional power. Under Democratic presidents, the market has risen faster when there has been a check on their power. Real DJIA returns have been higher under Democratic presidents and Republican or split Congress combinations than Democrats controlling the White House and both chambers of Congress. Conversely, markets have fared better when Republican presidents have enjoyed legislative majorities.
An important caveat is that there are so few cases that one-off events can skew returns. For example, the only instance of a Democratic president and split Congress was under Obama from 2013-2017. Also, large portions of the 1931-33 and 2008-09 crashes came under Republican presidents and Democratic or split Congresses.
What about a contested election?
The 24-hour news cycle is filled with stories about the various events that could spark a contested election, or Trump even refusing to leave office. At BWM, we always try to keep our opinions apolitical, rooted in fact and informed by relevant historical events.
One likely scenario involves an issue around mail-in voting. The pandemic has spurred several states to expand mail-in voting. Because each state sets its own rules, some states may not declare a winner on November 3. In addition, President Trump has questioned the validity of vote-by-mail balloting, raising the possibility of a contested election. The U.S. Constitution is clear on who certifies an election (Congress), but how it is done is less defined.
While it is not our focus to debate mail-in voting, we do want to examine how election confusion has historically impacted the stock market. Remember: the market hates uncertainty, and political uncertainty is no exception. Most periods of election confusion have been associated with weak stock market performance.
As an example, we can look back 20 years to the 2000 election. The 2000 election is the only one in the last 120 years in which the winner was not known with reasonable certainty by the time the markets opened the day after the election. Several states were too close to call, including Wisconsin and Oregon, but Florida’s 25 electoral votes would determine who would win the presidency. The process was incredibly complicated in Florida, but it came down to court battles over recounting votes. After several appeals, on December 12, the U.S. Supreme Court effectively ended the recount and gave Bush the victory.
As shown below, the DJIA was already down 4.5% year-to-date through the November 7 election day. The index dropped in the following days and weeks, falling as much as 5.3% through December 1. It failed to recoup its Election Day level before year-end. In this situation, other complicating factors were also present in addition to the election uncertainty—namely, the bursting of the dotcom bubble.
Current positioning: Waiting to add additional risk
After rebalancing at the March lows and some small adjustments since, our portfolios remain roughly neutral in terms of our allocation to equities versus our benchmarks. While several market signals have supported a slightly more aggressive allocation, we are holding off on adding additional risk exposure with the election just a few short months away, unless something significantly changes. As we’ve repeated before, the market hates uncertainty and this election has the potential to deliver loads of uncertainty. We have an allocation in each of our portfolios to short-term bonds that we could use to take advantage of any pre- or post-election buying opportunities that may arise.
Investing involves substantial risk. BWM Financial and Stratos Wealth Partners (the “Firm”) do not make any guarantee or other promise as to any results that may be obtained from the Firm’s “letter”. While past performance may be analyzed in the Letter, past performance should not be considered indicative of future performance. All indices are unmanaged index which cannot be invested into directly.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. No reader should make any investment decision without first consulting his or her own personal financial advisor and conducting his or her own research and due diligence.