posted on August 05, 2016 19:43
This year’s election is shaping up to be one for the history books. Ever-changing social and economic issues, unconventional candidates, and citizens irritated by uncooperative politicians are all contributing to this hotly contested and widely covered election season. While the media blasts new headlines on a daily basis, investors are left wondering, “What does this mean for my portfolio?!” Following the evidence, we will take a closer look into whether either political party fosters a better climate for financial markets.
Despite sharing the common goal of wanting what is best for the country, Democrats and Republicans often have conflicting views on how to reach that goal. There is no better example of this than the 2016 presidential candidates: Hillary Clinton and Donald Trump. Putting personal opinions about the two candidates aside, the question is which political party has the recipe for healthier markets. Although Figure 1 shows stronger returns for Democratic presidents than Republican presidents, there are too many other important factors that affect stock market returns to draw a definitive conclusion. The U.S. stock market has enjoyed periods of robust returns under presidents from both parties. To say that one president caused stronger or weaker returns would be overestimating their ability to control the markets. Presidents tend to react to economic conditions rather than proactively control them. While the uncertainty of an election year tends to increase volatility, research shows that 14 of the past 16 election years have finished with positive returns – averaging 10.2%.
No matter the political stance of the president, most legislation cannot be passed without crawling through Congress first. Historically, markets have fared better under a Republican Congress (Figure 1) – but once again there is no definitive pattern and not enough evidence to proclaim a winner. Beyond that, a split Congress (e.g. a Republican-run House of Representatives and Democratic Senate or vice versa) has provided the best historical returns to date in a sample of ten occurrences since 1951.
Looking at the government all together, conceptually, some investors may prefer a divided government with the president and Congress hailing from opposing political parties for the natural system of checks and balances. Historical data for that scenario, however, shows that a unified government (e.g. Republican president and Republican Congress) slightly outperformed a divided government (e.g. Republican president and Democratic Congress) with average returns of 12.3% versus 11.2%, respectively. Based on that data, history shows that the market does not care whether government is unified or split. Furthermore, the data does not show that either party has a profound effect on how the market performs in the coming years.
Among the partisan hallways in Washington D.C. and across the country, Democrats may argue that the president has a stronger effect on the market, while Republicans claim that Congress wields more influence over the strength of the market. Despite these differences, both parties acknowledge the presence of a lag effect. This means that the positive effects from laws influenced by one party may not be felt for years – potentially when the opposing party has assumed control. While plausible, there are too many other considerations to prove that the lag effect is or is not present. Were laws passed in the beginning, middle, or end of the presidential and Congressional terms? How did other laws passed around the same time affect these circumstances? At what stage in the economic cycle were the laws passed? How did other economies around the globe affect the outcome? Outside of the variables in this short list, there are many others that could influence the timing of the effects of legislation. Since both the actual returns and the presence of the lag effect are unprovable, we must rely on what the historical data shows: focusing on the long term, the market thrives regardless of which party wins the election.
The evidence shows us that despite speculation, financial markets generally should not be strongly influenced by the winner of the 2016 election. Therefore, it is important to keep focused on what we can control. Both candidates have pledged to alter the tax code which includes potential changes for individuals as well (Figure 2). While legislation moves slowly and neither candidate is likely to implement his or her entire plan, these potential changes make financial planning as important as ever!