Navigating Market Volatility Through Election Cycles
Andrea Gonzalez
Sports, Business and Culture Editor
As the U.S. presidential elections draw closer, investors are voicing concern about the impact of the election cycle on their portfolios. Yahoo Finance says the discussion on potential election results overshadows talks of inflation, interest rates, and recession fears. The moment calls for an analysis of the interplay between presidential election cycles and stock market performance. Yale Hirsch, creator of the Stock Trader’s Almanac, analyzed data from 1833 from which he suggested The Presidential Election Cycle Theory.
This theory displays a cyclical pattern in stock market performance linked to presidential terms. On average, the first two years of a presidential term tend to be the weakest for stocks as the winner focuses on fulfilling campaign promises, a period known as the heavy lifting. This is followed by recovery and potential peaks as the president prepares the economy for potential reelection. Is there such a connection between the stock market and U.S. elections? While the pattern exists, historical data suggests that election outcomes have little impact on market performance in the medium to long term, according to Morgan Stanley
Presidential Election Cycle Theory explores research spanning decades. The third year of a presidency overlaps with the strongest average market gains. According to Morningstar, the U.S. stock market returns have been generally positive throughout the final year of a White House administration, with the first quarter showing the strongest returns to investors, particularly in years of divided government with a democratic president. While American investors are concerned about the political impact of a rematch between Joe Biden and Donald Trump on their portfolios, historical data can offer more nuance.
It is older generations who express significant concern about the outcome, especially on the short-term volatility of their retirement savings and policy implications on Social Security and healthcare. For younger investors, the stakes are on career growth and personal debt management, which are less impacted by presidential elections. But fear not; research has shown that past cycles have not consistently caused market selloffs, and the stock market often remains steady, providing favorable returns despite looming political uncertainty.
At U.S. Bank Investment, strategists revealed intriguing patterns during election cycles spanning 75 years of market data. They concluded that divided government scenarios have noteworthy correlations with market performance: midterm elections consistently outperform the S&P 500 the year after midterms, regardless of party control in Congress – that is, “markets may simply be rewarding gridlock,” as the president’s party often faces setbacks in midterm elections. During the cycle, investors test the White House’s ability to unify the party behind the agenda.
Additionally, while presidential election results may not have a significant medium to long-term market impact, they could affect individual sectors and industries tied to regulation, proposed tax policies, global conflicts, immigration, and spending priorities, suggests the CFA Institute. Lastly, uncertainty varying election results introduces further short-term uncertainty in the market, leading to volatility in some asset prices until clarity emerges – i.e., raw materials, energy, etc.
Although the Presidential Cycle Theory has merit, definitive answers still need to be established. There have been 23 elections since the S&P 500 Index began, and 19 of the 23 (83 percent) provided positive performance. While market returns tend to be positive throughout the final year of a presidential term, attempting to time market action based on politics is complicated due to the limited number of presidential election cycles and many factors influencing the financial market.
As the U.S. approaches the presidential election, stock market concerns about the outcome may be overstated. Examining the complexities of the relationship between election cycles and market performance helps investors make informed decisions to navigate market volatility confidently, prioritizing their long-term strategies through short-term political fluctuations.
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