On November 8, US citizens have the privilege and responsibility of voting at polling stations, absentee ballots, or early voting sites for a variety of national, state, and local officials and policy proposals. The collective will of the majority of voters will be reflected in who occupies the White House, the balance of power in Congress, as well as in state capitols, legislatures, and more. The complexity of government in the US can be frustrating at times, but as Winston Churchill said, “Democracy is the worst form of government, except for all the others.”
For investors, the run up to the election always raises questions like, “What is going to happen to my investments if so and so wins (or loses)?” The implication is, “What should I do to protect myself from a bad electoral outcome?” A dangerous assumption in this line of thinking is the idea that a single signal or factor (e.g., who wins an election) is a direct and significant cause of stock market performance and people can position investment portfolios to take advantage of the expected outcome.
There is always so-called “evidence” presented that one outcome will be better than the other. Right now, the question du jour is which presidential candidate would be better for the stock market? Or, maybe more broadly, which political party would be better for investors?
In terms of which party’s presidents have enjoyed times of better stock market returns, (as measured by the S&P 500 stock index) since 1926 the numbers appear to heavily favor the Democratic office holder. The average yearly return for the 47 calendar years a Democrat occupied the White House was 15% through year-end 2015. The 43 Republican years averaged 8.6%. However, when a Democrat served as President alongside a Republican-controlled House and Senate (9 calendar years), the average return rises to 16.3%. If you compare total control years (one party controls President, House and Senate), Republicans (11 years) have the edge, 15.57% over the Democrats at 14.52% (34 years). You can see where this is going; a creative politician can find what appears to be “evidence” for having Republicans or Democrats in control. It depends on how you measure “control.” *
Statistically, we have 90 years of data (90 calendar year data points), an extremely small sample from which to draw any conclusions. In a recent analysis by Dimensional Fund Advisors, they find when measuring monthly returns since 1926, those months in which presidential elections were held had returns (both positive and negative) which were “well within the typical range of returns regardless of which party won.” In other words, it didn’t make any difference.
In the book, Thinking Fast and Slow, Nobel Prize-winning economist and psychologist Daniel Kahneman uses the acronym “WYSIATI” to describe a common thinking error that applies to our discussion. The acronym stands for “What you see is all there is.” In the case of whether a Democrat or Republican in the White House would be better for the stock market, an investor is focusing on one signal, or data point, as though it is the primary predictive influence. What you see (“Who occupies the White House”) is all there is. In reality, as we all know, the complexity of factors influencing stock market performance is myriad. By introducing one other data point, total control of the executive and legislative branch, we get a different result. So, which one is “right” or most predictive? There is no way of knowing with any statistical certainty.
While the idea of predicting stock market performance based on a single signal is a popular diversion for the media and conversation, investors always gain the most benefit when they structure their portfolios for long-term success based on their personal financial goals, rather than who they plan to vote for in November.
* Source data from Morningstar Direct SM and www.infoplease.com
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