The Independent Market Observer

How Will the Presidential Election Affect the Stock Market?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Aug 11, 2020 1:42:12 PM

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electionWe’ve reached that point in the election cycle where I've started getting questions, from both sides, about the effect of the upcoming election on the markets. “Surely,” the question goes (and note that it is not really a question), “if Candidate X wins, the market will tank for the following reasons . . .”

There were similar questions during the last election cycle. You may remember the predictions of doom if Trump were to win. You may also remember the election before that, with the predictions of doom if Obama (the socialist) were to win. Yet, in both cases, the markets did quite well. Despite the very real fears, the markets managed to move upward with both.

The power of politics?

Politics has less of an effect on the economy and, therefore, the markets than we think. Since 1900, according to Bespoke Research, the average gain for the Dow Jones Industrial Average has been 4.8 percent per year, reflecting the economy as a whole. Decade after decade, markets have moved ahead as the economy grew, regardless of the party in power.

When we do see a political influence, it is not what might be expected. The average Republican administration over that time period saw gains of 3.5 percent per year, while the Democrats saw gains of almost twice as much, at 6.7 percent per year. Recent decades have seen the same pattern, with annual gains under Clinton and Obama exceeding those of both Bushes and Trump (so far).

Put in that context, fears about the election look to be overstated. Trump is a known quantity. So, if he is reelected, the effect should be minor. If the Democrat is elected, history shows that there is a good chance that, over time, the markets will do at least as well.

Could it be different this time?

It might. Biden plans to raise taxes significantly if elected, which would hit corporate profit margins. If margins decline, so do earnings—and so does the stock market. Higher taxes on the rich would also presumably hit their spending, which would be a drag on growth. These are real concerns.

They are not, however, any different from the concerns that normally accompany a Democratic administration. And, as noted, the Democrats have historically generated higher market returns. Why? Higher taxes are accompanied by higher spending, which also acts to stimulate the economy and the market. We have seen the same effect in recent months, when increased spending by the Trump administration has kept the economy afloat, and a Biden administration would likely expand that support.

Is this normal?

Indeed, this is a normal political cycle. The Republicans take office and cut taxes and spending, and the Democrats then take office and do the reverse. We have seen this pattern many times before, most recently with Obama to Trump. 

It is also normal, however, for both sides to make the change look as apocalyptic as possible in hopes of motivating their donors and voters—and that is exactly what we are seeing at the moment. The headlines that point out these likely changes are designed to get maximum attention by maximizing the potential consequences. Hence, the questions and concerns.

The reality, however, is likely to be much less scary. The next president will likely have to deal with a divided government, limiting the administration’s ability to pass any significant changes. Even if the Democrats were to take the Senate, a Biden administration would not have a filibuster-proof majority and likely could not rely on all the Democrats to vote for anything radical. The American political system is designed to be hard to change. Nothing in this election will change that, no matter who wins.

So, where does that leave us?

As investors trying to analyze the election, we should take note that there are certainly risks, but also opportunities. No matter who wins, there will be policy changes, but almost certainly nothing too radical. The real risks will come from reactions to the headlines, rather than to the underlying data. In other words, we should treat this like any other event and act on what actually happens, rather than on whatever disaster the headlines are peddling today.

Keep calm and carry on.

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