November 2, 2016
November 2, 2016
With the election just a few short weeks away, there is no shortage of strong opinions about the two remaining candidates and how this election is going to play out. There is also no shortage of opinions about how this election will affect the markets and your investments. In the last week alone I have come across multiple articles explaining why markets will rise/fall depending upon whether Trump or Clinton wins the presidency. These articles, though sometimes entertaining, are not of much use for long-term investors.
There are generally two approaches forecasters are taking to predict the impact of the election on stocks. One approach uses historical election results and stock market returns to predict post-election returns. The other approach predicts post-election market moves based on each candidate’s communicated policies.
The problem with using historical election results to predict post-election stock market returns is the small size of the data. Historical data for the S&P 500 Index goes back as far as 1926, but there have been only 22 presidential elections since then. Republicans won 10 of those elections and Democrats won 12. Even if the results showed a significant difference in stock returns when one party was in office, there isn’t enough data to have any confidence in the result. The same is true for studies that look at various combinations of Republicans and Democrats in the executive branch, the house, and the senate. There just aren’t enough instances of each possible combination to have any predictive power.
The second approach to analyzing the potential impact of the election is to assess each candidate’s polices and to try to determine the impacts the policies will have on the markets. This is particularly of interest this election year given what some believe are extreme policies held by both candidates. For instance, some believe that the stock prices of energy and pharmaceutical companies will crash if Clinton is elected. Others believe that President Trump’s populist policies would lead to a broad stock market decline. But does it make sense to change your portfolio now to reflect these or other views about the election? Probably not. Even if you were able to correctly predict the outcome of the election, it remains very difficult to predict how stock prices will react. The fact is there are many other forces that have an impact on stock prices besides what is going on in Washington. Monetary policy, corporate earnings, or some unforeseen event might well have a greater impact on stock prices than the immediate results of the election.
But what if Trump gets elected? Won’t his unpredictable style cause the markets to sell-off? They might, at least initially. But the fact is that we do not know with certainty what the impact would be in the longer-term. The most recent shock the markets experienced was the Brexit vote in the United Kingdom, which was also a populist referendum. Stocks in the UK dropped sharply after the vote was passed, but have since rebounded to an all-time high.
There is no way to know with certainty how the markets will respond to the results of the election, and repositioning your portfolio based on short-term predictions can lead to disastrous results. That does not mean that repositioning may not be necessary in the future, but for now, we believe it makes more sense to focus time on how you are going to vote the election, instead of how to trade it.