Blue Wave or Red Tide: What Is Best for The Market?

 "Donald Trump - Caricature" by  DonkeyHotey

"Donald Trump - Caricature" by DonkeyHotey

I went to early vote last Friday. It was mid-morning and the wait was nearly an hour. For some reason, folks seem extra motivated to participate in our representative democracy in this mid-year election. In fact, according to The Texas Tribune, early voting totals across Texas are only slightly behind where they were during the 2016 Presidential election, and more than double the number seen in the 2014 mid-terms.

While we won’t know the outcomes of the elections until next Tuesday night, one thing we can count on is that plenty of political advertisements, opinions, and prognostications will be shared in the days to come. Pundits will want you to believe that this election, unlike all before it, is the most important vote you will ever cast. The results, they claim, will have lasting impacts on the economy, society, and even the planet.

In financial circles, this talk will almost assuredly include how the composition of the House and Senate could move markets. But should you be worried about how this mid-term election will impact your portfolio?

MARKETS WORK

It is said that markets climb a “wall of worry”, and elections certainly highlight many of the things that concern us all. However, I urge caution to anyone from making short-term adjustments to a long-term plan or trying to profit or avoid losses from changes in the political winds. For context, it is helpful to think of markets as a powerful information-processing machine. The combined impact of millions of investors placing billions of dollars’ worth of trades each day results in market prices that incorporate the aggregate expectations of those investors. This makes outguessing market prices consistently very difficult. While surprises can and do happen in elections, the surprises don’t always lead to clear-cut outcomes for investors. The 2016 presidential election serves as a recent example of this. Remember any of these headlines?

 

There were a variety of opinions about how the election would impact markets, but many articles at the time posited that stocks would fall if Trump were elected. The day following President Trump’s win, however, the S&P 500 Index closed 1.1% higher. So even if an investor would have correctly predicted the election outcome (which was not apparent in pre-election polling), there is no guarantee that they would have predicted the correct directional move, especially given the narrative at the time.

But what about congressional elections? For the upcoming midterms, market strategists and news outlets are still likely to offer opinions on who will win and what impact it will have on markets. However, data for the stock market going back to 1926 shows that returns in months when midterm elections took place did not tend to be that different from returns in any other month.

Exhibit 1 shows the frequency of monthly returns (expressed in 1% increments) for the S&P 500 Index from January 1926–August 2018. Each horizontal dash represents one month, and each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months where returns were between 1% and 2%). The blue and red horizontal lines represent months during which a midterm election was held, with red meaning Republicans won or maintained majorities in both chambers of Congress, and blue representing the same for Democrats. Striped boxes indicate mixed control, where one party controls the House of Representatives, and the other controls the Senate, while gray boxes represent non-election months. This graphic illustrates that election month returns were well within the typical range of returns, regardless of which party won the election. Results similarly appeared random when looking at all Congressional elections (midterm and presidential) and for annual returns (both the year of the election and the year after).


  Exhibit 1.  Midterm Elections and S&P 500 Index Returns, Histogram of Monthly Returns January 1926–August 2018

Exhibit 1. Midterm Elections and S&P 500 Index Returns, Histogram of Monthly Returns January 1926–August 2018

Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.


IN IT FOR THE LONG HAUL

While it can be easy to get distracted by month-to-month or even one-year returns, what really matters for long-term investors is how their wealth grows over longer periods of time. Exhibit 2 shows the hypothetical growth of wealth for an investor who put $1 in the S&P 500 Index in January 1926. Again, the chart lays out party control of Congress over time. And again, both parties have periods of significant growth and significant declines during their time of majority rule. However, there does not appear to be a pattern of stronger returns when any specific party is in control of Congress, or when there is mixed control for that matter. Markets have historically continued to provide returns over the long run irrespective of (and perhaps for those who are tired of hearing political ads, even in spite of) which party is in power at any given time.


cONGRESS CONTROL.png

Exhibit 2. Hypothetical Growth of $1 Invested in the S&P 500 Index and Party Control of Congress January 1926–August 2018

Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.


Equity markets can help investors grow their assets, and I believe investing is a long-term endeavor. Trying to make investment decisions based on the outcome of elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely be the result of random luck. At worst, it can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, to pursue investment returns.

Early voting ends today. Election day is next Tuesday. If the outcome has you worried about your financial future, get in touch for a review.


Source: Adapted from Dimensional Fund Advisors LP November 2018 Issue Brief.

Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.

There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.