In their never-ending effort to predict where the markets are headed, analysts most often rely on valuation data such as price-to-earnings ratios or economic data such as the prevailing yield curve in the U.S. bond market.
But some venture into more esoteric territory, including using various technical analysis tools and even going as far as studying how weather patterns and dwindling sunlight in the autumn affect investor behaviour.
Another perennial favourite of forecasters and media commentators is to link political developments to possible stock market outcomes. They’ve been at it again recently, trying to gauge how next week’s U.S. mid-term elections will affect the markets.
It’s part of a long tradition of trying to understand the impact of U.S. elections on investors. Researchers have looked at the question from every angle, including when Democrats or Republicans win control of both the White House and Congress as well as when power is divided between the two parties.
For example, U.S. Bank analysts looked at the performance of the S&P 500 during 15 mid-term congressional election cycles – those held between presidential elections – dating back 60 years.
Their study found that the S&P 500 underperformed in the year leading up to a mid-term election (0.3% gain versus a historical average of 8.1%). By contrast, the index significantly outperformed in the year after the election, with an average return of 16.3%. (This article gives the results for a similar study of U.S. presidential elections.)
While that kind of research can be entertaining, it shouldn’t affect how you invest for several reasons.
First, political effects tend to be short-lived and are notoriously hard to predict. In 2016, for example, Donald Trump’s tumultuous presidential campaign raised fears among some commentators that a victory would hurt stocks. However, Trump’s surprise win sent the S&P 500 soaring 5% in the first month and it continued to rise strongly through most of his term, as he never tired of telling the public.
Second, it’s impossible to sort out whether political effects are moving the markets or other factors such as the interest rate environment, consumer demand or a global pandemic. In the case of the U.S. Bank analyst research, 15 observations does not make for a statistically significant sample size, even though it may sound like a lot. There is no way to tell if the outcome (underperformance in mid-term years) is reliably tied to the variable (mid-term election year vs non-election year).
Third, the markets have thrived over the long term under both Republican and Democrat control in Washington. This video from Dimensional notes that investors buy companies, not a political party, and have been rewarded for doing so for many decades, regardless of who is in power.
Finally, when you hold 60 countries in a diversified portfolio, there will always be some experiencing political upheaval, just like there will always be some bad individual stocks in the mix. However, you’ll also never miss out on the good ones, and in the long run, the portfolio return will be more reliable.
We can set expected returns decades out and have confidence that we will achieve them because one bad company or one bad country won’t ever damage the entire portfolio.
Sticking with a broadly diversified, passive investment approach that’s grounded in academic research is the right way to build your wealth through all political seasons.