Wealth Matters Newsletter - October 2020

Policy or Politics?

Written by: Mark P. Bernier, CFA, Senior Vice President/Wealth Management Officer

Over the last several weeks, many conversations we’ve had about the markets have been focused on the impact of the upcoming elections. “What happens if…?” Clearly, many investors are nervous in an election year unlike any we’ve had in memory. Elections offer another source of uncertainty and thus volatility investors will have to navigate; we have to look no further than the previous U.S. presidential election cycle for proof.  Before we review our positions on different election outcomes, we’ll first provide some historical context on past performance of the stock market around U.S. elections.

First, consider the following statistics from Dan Clifton of Strategas Research Partners:

  • Since 1933, a Republican House, Democratic Senate, and Democratic President saw the S&P 500 provide the highest average annual returns of 13.6%.
  • A Democratic House, Republican Senate, and Republican President (the current split) saw the S&P 500 generate average annual returns of 10.8%.
  • A Democratic House, Republic Senate, and Democratic President has not occurred since 1886.

Consider, too, the following chart from Jurrien Timmer of Fidelity Management & Research Company:

Chart from Jurrien Timmer of Fidelity Management & Research Company

Dark blue bars in the right panel, indicate returns during the first 2 years of a president's term. The light blue bars show the 4-year return. Monthly data since 1789 (mix of S&P 500, Dow Jones Industrial Average, & Cowles Commission). Source: FMRCo.

Considering that historical context, market volatility around elections tends to be short-lived.  Longer-term market returns are driven by economic cycles, not election outcomes, as evidenced by the fact that average returns were positive in each instance depicted earlier. With that in mind, the following are likely short-term market movements in response to the upcoming elections under various election outcome scenarios:  

Outcome 1: No change.

If President Trump remains in office and the current party complexion of Congress remains unchanged, investors will refocus on the pace of the global economic recovery, corporate earnings, vaccine prospects, and trade in 2021.  We would not expect a significant increase in cooperation in Congress to move any significant legislation forward.

Outcome 2: Joe Biden wins the election and Congressional majorities remain unchanged.

The aftermath is likely similar to Outcome 1.  If Congressional majorities remain unchanged, it will be difficult, at best, for the President to accomplish any of the major policy initiatives.

Outcome 3: President Trump remains in office and Congressional majorities swing to single-party control.

The market’s response in this instance is dependent upon which party controls Congress.  In a Republican sweep, stock markets may move higher.  Investor’s would likely view this change as a continuation of favorable tax policy and reduced regulation.  In a Democratic sweep of Congress, markets would likely come under some selling pressure.  Impeachment proceedings may be back on the table in 2021 and Congress would likely be facing a constant stream of vetoes for any bill presented to the President.

Outcome 4: Joe Biden is elected President and Congressional majorities swing to single-party control.

Like Outcome 3, if Republicans sweep control of the House and Senate, it will be difficult for the President to accomplish much other than through executive order.  Markets may move sideways on that outcome.  Democrats sweeping Congressional control would likely have this biggest short-term impact on the markets.  Likely changes to tax law in 2021 would motivate some investors to lock in capital gains at likely more favorable rates in 2020. Selling pressure would likely be focused on large-cap tech stocks, as this part of the stock market experienced the biggest gains over the last several years and also represent the largest segment of the S&P 500.  In addition, these companies may face greater regulatory scrutiny under a Democratic regime.  In this scenario, high-quality dividend paying stocks and other value-style investments may take over market leadership going into 2021.
Regardless of which permutation actually occurs, a delay in the result will also weigh on investors’ minds and appetite for risk.  Much like the delay in the presidential election of 2000, defensive sectors would likely be the best performing parts of the stock market if we find ourselves in a similar post-election quagmire.

In the short-term, investors respond to election results not as a referendum on investor preference, but as a reflection of the administration’s agenda and associated policy changes that can affect profitability. Over the long run, policy, not politics, is the bigger driver of long-term returns; market movements around elections are just a blip on the radar and election results should not derail your long-term investment goals or strategy.  If you would like to review your current investment strategy, please give us a call.

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