The Markets and Presidential Elections

FOR VOTERS, THE 2020 ELECTION represents an opportunity to help determine who will guide the country through a period of historic challenges. For investors, it creates one more source for potential market volatility.

“Volatility has been a classic hallmark of presidential election seasons,” says Marci McGregor, senior investment strategist for the Chief Investment Office, Merrill and Bank of America Private Bank. Historically, the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, which tracks the market’s expectations for volatility over the following 30 days, rose on average 30% in the months that led up to election day.¹

This year, with an expected tight election and no clear path forward on issues ranging from the coronavirus pandemic to racial inequality and international trade, “uncertainty over U.S. economic policy is close to an all-time high,” says Savita Subramanian, Head of Environmental, Social and Governance (ESG) Research and Head of U.S. Equity and Quantitative Strategy, BofA Global Research.

Another source of uncertainty: the logistics of the election itself. A surge in mail-in voters due to the pandemic raises the possibility of a delay in certainty about the final outcome of the sort not seen since the 2000 election between Republican George W. Bush and Democrat Al Gore. “Those four or five weeks before Gore conceded were not a good time for the S&P 500,” McGregor says.

What history shows us

Yet despite such concerns, past election cycles showed that volatility has usually been temporary and that markets rebounded. Since the end of World War II, the S&P 500 has averaged 11.7% returns in the first year of a presidential term, 9.7% in year 2, 19.1% in year 3 and 10% in the final year.² Regardless of party, markets historically prefer the continuity of an incumbent, McGregor notes. In the first year after an incumbent victory, S&P 500 returns have averaged 14%, compared with 6% under a new president from a different party.³

Another consideration is whether one party sweeps the presidency and all of Congress, or the election results in a divided government. “The myth is that gridlock is good for markets because it prevents governments from doing harm, but the reality is more nuanced,” McGregor says. In postwar years with full Republican or Democratic control, the S&P 500 has averaged 18.6% and 14.8% total returns, respectively. By comparison, Democratic presidents with a Republican Congress and Republican presidents with a Democratic Congress have averaged 15.9% and 8.6%.⁴ Since World War II, the S&P 500 has averaged 15.6% returns under Democratic presidents and 10% under Republicans.⁵

Which industries could potentially benefit?

“Consumer sectors, materials and utilities have historically performed better under Republican presidents, while technology, health care, financials and industrials have performed better under Democrats,” Subramanian says. “Communications services and energy have tended to perform similarly regardless of who’s in the White House. And contrary to popular belief, the aerospace and defense sector has historically performed better under Democrats,” she adds.

Yet past performance is no guarantee of future results, and markets in the years to come will be affected by many factors beyond election results. “Coming out of a recession, we believe we're in the early innings of a new economic cycle and a long-term bull market,” McGregor says. “The early innings can be very rocky, but are also often a time when monetary policy is most supportive.”

Likewise, either party will face some stiff economic challenges that could affect economic growth. “No matter who wins, they are going to face a massive deficit and debt that may have implications for future growth,” McGregor says. “That’s just where we are today.”

The greatest election risk for investors

For investors, the greatest election risk may come in attempting to act upon events as they unfold. “Timing the market by quickly getting in or out is typically a losing proposition,” McGregor says.

Because elections can be unpredictable, the best course is to work with your advisor to ensure that your portfolio addresses your best interest and is well-diversified. Periods of volatility may call for more frequent rebalancing to keep your portfolio positioned to meet your long-term goals. “Yes, some sectors may be poised to benefit or fall out of favor depending on the results,” she adds. “But at the end of the day, staying invested could potentially benefit you as a medium- and long-term investor.”