With less than a month to go before the election, many readers have asked me how the outcome could affect their investments. Let’s start with my usual advice: You should not make changes to your portfolio in an attempt to outfox the tried and true practices of long-term investing.
What are those practices? Identifying your personal goals and objectives; creating and sticking to a diversified asset allocation plan using low-cost index funds; and rebalancing two to four times a year.
That said, the following should be filed under the heading “Fun with facts and figures” — not prescriptive advice as to how to reallocate your portfolio. There are going to be a lot of articles and news segments — not to mention political ads — discussing which candidate is better for your money, the markets and the economy. Don’t take them too seriously.
Let’s start with the Presidential Election Cycle Theory, which holds that, regardless of whether Republican or Democrat wins the election, U.S. stock markets are weakest in the following year, improve in the second year, peak in the third year and then are weak in the fourth year. This theory has held up even better for two-term presidents.
But like almost every market theory (e.g., “The January Effect,” “Sell in May and Go Away”), there are always exceptions to the rules. In fact, while the theory held up well through most of the 20th century, it has been less reliable lately. The last four years have largely refuted it. In the first year of President Obama’s second term, the Dow saw an impressive 27 percent gain, followed by 7.5 percent in year two. Last year, which was supposed to be the strongest of the cycle, the blue chip index dropped by 2 percent. The Dow is up 5 percent through the first three quarters of this year.
How does the president’s party affect the stock market? Data show that since World War II, the average compound annual growth rate for stocks is 9.7 percent under Democratic presidents and 6.7 percent under Republicans. The analysis can be carved up lots of different ways, depending on a split Congress, and chances are you can find the combination that supports the way you want to vote.
But a recent academic study, “What to Expect When You’re Electing,” finds that there is “no systematic difference between Republicans and Democrats” when it comes to steering the direction of the stock market. What does matter is the direction of interest rates: The stock market tends do better when rates are going down than when they are rising.
Maybe we are looking at this backwards: According to InvesTech Research, the market may be a better indicator of the presidential election than vice versa. If the stock market is up in the three months leading up to the election, the incumbent party usually wins. Declines over those three months tend to mean a new party will take control. In the 22 presidential elections since 1928, exceptions occurred in 1956, 1968 and 1980. In other words, the S&P 500 has an 86.4 percent success rate in forecasting the election.
You may still be wondering: Who’s better for my bottom line, Trump or Clinton? In the end, though, isn’t it better to know that the party that prevails will have far less to do with your portfolio’s performance than bigger macroeconomic trends?
Instead of trying to outsmart the market, my advice remains simple: Address what is within your control by creating a financial plan.