Broker Check

Politics and Stock Market Performance

| April 05, 2018
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How U.S. Stocks Have Performed During Republican and Democrat Control of Congress

It is difficult to dispute the fact that government policy and political events have a pronounced influence on financial markets. However, stock market returns are the result of many different factors, so it is not always possible to establish a direct connection between developments in financial markets and the world of politics. Regardless, there are a few identifiable historical patterns that are worthwhile enough to mention. The purpose of this paper is to explore some of the trends and relationships that have persisted historically between the US political backdrop and financial markets.

The Market Prefers Republican Control in Congress

It’s too early to say whether Democrats will recapture both houses of Congress in the upcoming November mid-term elections. Conor Lamb’s (D-PA) win over Rick Saccone (R-PA) in the recent special congressional election in Pennsylvania’s 18th district has bolstered Democrat’s hopes for a shift toward majority representation. Lamb was able to best Saccone by just 627 votes, in a district that President Trump carried by almost 20 percentage points in 2016. Defeat in this bellwether vote, and looming concerns about further losses in November may begin to start wearing on the confidence of Republicans. It seems now, based on the changing political tides, that a shift toward a Democratic majority in both chambers is quite possible. Republicans are now becoming very cognizant of that risk.

Even with the momentum from Lamb’s recent win, the Democrats have a long and difficult road ahead. In fact, they would need a net gain of 24 seats in November to hold a majority in the House. Recent polls of voter preferences and results from recent state elections indicate that this outcome is within reach. Moreover, they only need two seats to claim the Senate; however, Democrats face a bigger challenge there since they’ll also be defending 26 seats (compared with only eight for the Republicans).

Historically speaking, when Republicans controlled both houses, times have coincided with outsized equity gains. On the other hand, the S&P 500 has underperformed since 1954 when Democrats have held control over both chambers. The chart below further illustrates the relationship between politics and stock-market performance since 1955.

In the three periods since 1955 during which Democrats have controlled both houses (when the HSE and SEN tags on the chart are both blue), the S&P500’s annualized return for the terms covered was approximately +5%, +7%, and -3%, respectively. Conversely, the S&P500 index enjoyed annualized returns of +19% and +15% in the two periods when Republicans controlled both chambers. Currently, as we enter into the third year under majority Republican control, the S&P500 is hovering at annualized gains over 10%.

Presidential Cycles: Rinse and Repeat

The 20th amendment to the U.S. Constitution establishes that presidential elections must occur every four years, with the newly-elected president assuming office the January following an election year. Once in office, presidents usually endeavor to make the economy as healthy as possible in an effort to ensure reelection at the end of their first term. The consistency behind this U.S. political process sets into motion fiscal policies (an increase or decrease in taxes and government spending) that are, to a certain point, predictable (as is their effect on financial markets). The direction these fiscal policies take is often times related to the state of the economy during an election year.

It’s not at all out of the ordinary to see incumbent presidents cater to voters by promising tax reductions and increased spending on government programs as an election year draws closer. Furthermore, an incumbent political party may try to persuade the Fed to complement the administration’s agenda through the use of monetary policy (increasing the money supply and reducing interest rates). Fiscal and monetary policies can be introduced as early as the first year of each presidential four-year term. If these policies yield favorable results the economy responds positively, paving the way for corporate profits to increase and with them equity prices – just in time for the next presidential election.

Once enacted, U.S. fiscal and monetary policies have a direct impact on equity markets. Furthermore, cyclical patterns in stock market performance have emerged within each repeating four-year presidential cycle. Looking all the way back to 1950, we’ve found that the last year of each presidential term (the actual election year) has generally been good for equities. In fact, the S&P 500 rose 81% of the time and yielded an average return of about 6.6%. It is important to note that these results include the most bearish election year to date, 2008, when the S&P 500 dropped 37%.

The first year of the presidential cycle, immediately following the election year, has historically been the toughest for equity markets. Out of the total 16 cycles studied, only nine resulted in positive stock gains during that time. The third year within each four-year cycle, the year before the actual election year, was generally the best performing year for equities. In fact, the S&P 500 rose in all except two of the seventeen most recent cycles studied, establishing average returns of 16.4%.

Conclusion

Our research shows that there are significant, and often times repeating, market trends that are closely correlated to cyclical shifts within the U.S. political landscape. Election cycles, both in the executive office and Congress, and the resulting changes to policy have the power to sway financial markets. However, it is important to note that although the above-referenced series of cause and effect relationships appears logical, the sequence of events does not always play out in lockstep. There is sometimes a delayed economic response to policy changes, not to mention other outside non-political factors that can have a dramatic impact on markets (i.e. commodity prices and the US Dollar). There are no assurances that a shift toward a Democratic majority in Congress would trigger a negative response from equity markets, or that we can expect outsized gains during President Trump’s third year. All the same, as prudent investors, and stewards of our clients’ financial future, we must recognize the importance of the aforementioned historical relationship between US political cycles and equities. Here at Tompkins Financial Advisors, we continue to carefully monitor our portfolios, keeping a close watch on unfolding political events and their potential impact on financial markets.

Important disclosures

Investments are not insured by the FDIC, not deposits of, obligations of, or guaranteed by the bank or its affiliates, and are subject to investment risk including possible loss of principal.

Work Cited:

• Perry J. Kaufman, Trading Systems and Methods, 5th Edition (Hoboken, New Jersey: John Wiley & Sons, 2013), Chapter 11

• “How Do Stocks Perform During the Presidential Election Cycle?” Charles Schwab, May 13, 2016, https://www.schwab.com/resource-center/insights/content/how-do-stocks-perform-during-presidential-election-cycle

• Nickles, Marshall and Granados Nelson. “The Four-Year U.S. Presidential Cycle and the Stock Market.” Graziadio Business Review, 2012 Volume 15, https://gbr.pepperdine.edu/2012/10/presidential-cycle-and-stock-market/

 

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