Elections: Perception Versus Reality
October 23, 2020
It’s shaping up to be a presidential election season like no other. It feels like we say this every four years, but this year it certainly feels very different. Whether it be the hardships inflicted by Covid, the increasingly polarizing political platforms, or the growing influence and reverberation from mainstream and social media inundating us with images and opinion, this election seems like nothing else. Naturally, our clients have questions. What would a Democratic wave do for markets? Would a contested election cause markets to collapse? What industries benefit or get hurt under different administrations and how should we position ourselves in advance? With the election now less than two weeks away, we felt it was appropriate to take a break from our normal commentary in order to speak specifically to the election and what we think it means for investors.
Anyone having read our commentaries understands that a lot of what we try to do in our analyses is to look through the daily noise in order to see the bigger picture. It isn’t that the noise isn’t important. It is that the noise is temporary and constantly changing such that, when contrasted against an economy that is remarkably stable (potential shocks to an economy such as Covid noted), it can distract from the true reality and thereby influence one’s investing behavior in negative ways. Political rhetoric is noise, and while rhetoric may have threads back to specific policy implications, the legislative process itself typically dulls what is ultimately passed. Rhetoric is what elections run on, however. It is what gets voters to the polls, but that same emotion and motivation should not derail a disciplined investing plan. Every election is cast as a do or die moment, and make no mistake about it, many have been just as contentious as the one that lies ahead of us on November 3rd. Markets have endured contested elections, social unrest, mandates for wealth redistribution, racial protests, claims of voter fraud and disease — mirroring contemporary concerns. Objectively, this election is not unique in its place in history. While we will briefly touch on the implications for each candidates’ platform, the focus in this piece is really to illustrate what impact political control has had on market returns historically. We’ve done so understanding that while the specific legislative priorities for the Democratic and Republican parties may have shifted over time, they’ve directionally remained consistent, with one generally advocating for greater government involvement in the economy and the other supporting a more laissez-faire approach.
To test how political control may influence market returns, we examined the past eighteen presidential elections to determine whether or not a president of a particular party tended to be associated with either positive or negative returns for the market. We examined modern, post-war elections from 1948 to 2016 (Truman to Trump) and what we found was that in ten of the 18 instances, irrespective of which party was elected, the very next calendar year return (“post-election year”) was positive by an average of 19.93%. Conversely, eight of the 18 post-election years posted losses which averaged -7.42%. Things start to get more interesting, however, when we began to break this down by party. The average post-election year return following a Democratic President has averaged 15.26%, while it has averaged just 1.79% following the election of a Republican President. At this most basic level, post-election years – particularly years in which Democrats get elected to the presidency – tend to be associated with higher than average returns. This is somewhat counterintuitive, but it begins to make more sense once you expand the analysis to include not only a party’s control over the presidency, but also consider which party has control of the House and the Senate. The chart below helps summarize these various control scenarios.
This summary provides several important insights. The first (left chart) is to simply show the average annual performance under various political control scenarios from 1933-2019. While the average annual market performance for all 86 observed years is 9.11%, the market outperforms this average when there is either a unified Republican government (i.e. the presidency, Senate, and House all controlled by Republicans) or when there is a Democratic president and either a split Congress (Senate controlled by one party and House controlled by another) or a unified, Republican congress. The takeaway is that the market prefers gridlock, and its preferred state is to have a Democratic president with the Republicans remaining in control of at least one of the two legislative bodies. Under this scenario, the market has managed to return 13.6% on average.
If, instead of looking at average performance during a particular control period, we instead look at near term average performance – again applying the same control scenarios – we find a similar conclusion. As the second chart illustrates (right chart), a Democratic presidency with either a Republican Congress or a split Congress outperforms all other control scenarios on a one-, two- and three-year, average, post-election basis. As we write this, the “conventional” thinking is that this year’s election will either result in a unified Democratic government or a Democratic president with a split congress – both of which have historically resulted in above average returns for the market. To the degree there are concerns over a “Blue Wave” and a negative impact on the market, this data suggests otherwise. Furthermore, should the Republicans continue to hold the Senate, we would revert to the market’s historically preferred control state.
All this, of course, requires one to believe that history is a guide, and that the rhetoric coming from the political camps is likely to be more severe than the resulting policy itself. We believe both are likely true, but that does not mean one can simply stick their heads in the ground and assume it is business as usual. We believe these statistics are meaningful from a directional standpoint, meaning that these numbers don’t suggest to us that elections serve as an event risk. The candidates’ policy proposals will certainly introduce new forces and pressures on specific industries within the broader market for which portfolios will need to be adapted over time. There will be headwinds for some and tailwinds for others. The most notable is for the oil industry, but there are implications for healthcare, banks, and cannabis – just to name a few. That said, the bigger factor for markets looking forward is each company and each industry’s adaptability, competitiveness, and innovativeness. We believe that while regulation and taxation may influence these, companies and markets will remain in control of their own fate irrespective of who sits in the White House. The notable caveat is with respect to monetary policy, which has typically remained outside the political realm. So long as monetary policy remains independent, we are otherwise sanguine over just how impactful this election ultimately may be for markets.
Our neutral outlook on markets does not extend to the conditions investors and savers are likely to face individually. The potential for a Democratic administration along with the expiration of several favorable tax provisions means that clients need to reassess their wealth preservation and estate planning strategies if they have not already done so. The focus on taxes during the election campaign has tended to be on personal income, business, and capital gains taxes, but the estate tax, the exemption levels, and stepped-up basis are likely to be ensnared as well. We encourage clients to meet with their advisors to review their present situation to assess whether changes to their current estate plan may be appropriate.
This has undoubtedly been a challenging year so far made more divisive by a national election that tends to polarize our society in the best of times. Like the pandemic, this too shall pass and our longer term outlook is not significantly altered based on November 3rd’s results.
The Week Ahead
We’ll have our first read on Q3 GDP and personal income spending.
Once in a Blue Moon
A rare lunar treat is on the horizon. The Earth’s moon goes through its eight major phases every 29.53 days, which means we usually have one full moon for each month, making the total 12 for a year. But every once in a while, some months will have two full moons since the phases of the moon don’t align perfectly with our calendar. This occurs every 2.7 years, and not only is it happening this month, but it just happens to be on Halloween this year. Furthermore, the Halloween full Blue Moon will appear in every time zone for the first time since World War II, according to the Farmer’s Almanac.
The first full moon of October occurred on October 1 and it was the Harvest Moon. The second full moon on October 31 will be the Hunter’s Moon. The names of full moons date back to early Native Americans and Colonial folklore. They were used to mark the seasons and describe activities or events typically occurring at the time. For example, the full Wolf Moon in January coincides with the howling of wolves that was often heard at that time of year. The full Snow Moon in February coincides with a time of heavy snowfall. There was some variation in the full moon names, but in general, the same ones were consistent among regional tribes and adopted by European settlers who applied them to their own calendar.
Whenever two full moons appear in a single month, the second full moon is called a Blue Moon. Hence, we describe any infrequent but not rare events as happening “Once in a Blue Moon.” This year, we will see the first Halloween full moon since 2001. A Halloween full moon only occurs roughly once every 19 years. According to astronomers, the next Halloween full moon (after 2020) will be in 2039, 2058, 2077, and 2096. Adding to the unusual year we are having, 2020 is also the first time a Halloween full moon will appear for all time zones since 1944. The 2001 Halloween full moon only appeared for the Central and Pacific time zones.
A Blue Moon every 2.7 years, combined with a full moon landing on Halloween which only happens every 19 years and that will occur in every time zone for the first time in three-quarters of a century is a rare trick for 2020. Well played, Mother Nature, well played.
Important Disclosure: The information contained in this presentation is for informational purposes only. The content may contain statements or opinions related to financial matters but is not intended to constitute individualized investment advice as contemplated by the Investment Advisors Act of 1940, unless a written advisory agreement has been executed with the recipient. This information should not be regarded as an offer to sell or as a solicitation of an offer to buy any securities, futures, options, loans, investment products, or other financial products or services. The information contained in this presentation is based on data gathered from a variety of sources which we believe to be reliable. It is not guaranteed as to its accuracy, does not purport to be complete, and is not intended to be the sole basis for any investment decisions. All references made to investment or portfolio performance are based on historical data. Past performance may or may not accurately reflect future realized performance. Securities discussed in this report are not FDIC Insured, may lose value, and do not constitute a bank guarantee. Investors should carefully consider their personal financial picture, in consultation with their investment advisor, prior to engaging in any investment action discussed in this report. This report may be used in one on one discussions between clients (or potential clients) and their investment advisor representative, but it is not intended for third-party or unauthorized redistribution. The research and opinions expressed herein are time sensitive in nature and may change without additional notice.