Election Year Economics: Don’t Get Caught Up in the Drama

Election years, particularly presidential elections, can bring a sense of uncertainty to the financial markets. With candidates proposing different policies and the potential for significant changes in governance, it's natural for investors and the general public to wonder how the economy will fare. However, while elections often create short-term volatility, the long-term economic impact is often much less significant than many anticipate. Let’s explore why.

Short-Term Volatility vs. Long-Term Stability

Market Reactions to Elections Financial markets are sensitive to uncertainty, and elections are a prime source of that. Leading up to an election, markets may experience increased volatility as investors react to polls, debates, and potential policy shifts. The U.S. stock market often sees fluctuations, particularly during presidential election years, with some sectors reacting more than others depending on the perceived impact of each candidate's platform.

However, historical data shows that while markets may react in the short term, the long-term trend is generally positive regardless of which party wins. According to research by Vanguard, the U.S. stock market has averaged annual returns of about 10% since 1926, and this growth trend has persisted through various political environments, including changes in party leadership.

The chart below shows the hypothetical growth of $1 invested in the S&P 500 from 1926 through 2022 as well as which U.S. President was in office during each year. 

Source: https://my.dimensional.com/one-pagers/what-history-tells-us-about-us-presidential-elections-and-the-market

What this chart illustrates is that it’s not possible to attribute predictably better returns to one party over the other; and even more importantly, that the market can make money regardless of whether it’s the “other” party in office.

Economic Fundamentals Over Politics While elections can influence market sentiment, the fundamentals of the economy—such as corporate earnings, interest rates, and technological advancements—play a much more significant role in long-term economic performance.

For instance, during the 2008 financial crisis, the economy was deeply affected by issues in the housing market and the banking sector, not by the election that took place that year. Similarly, the tech boom of the late 1990s drove significant economic growth, regardless of the political landscape.

The economy is also influenced by global factors beyond the control of any single government, such as international trade, geopolitical events, and pandemics. These factors often have a more profound impact on economic performance than domestic election outcomes.

 

Historical Examples: Economy Thrives Despite Election Uncertainty

The 2016 U.S. Election The 2016 U.S. presidential election was one of the most contentious in modern history, with markets experiencing significant anxiety in the lead-up to the vote. Many investors feared that a victory by Donald Trump would lead to economic instability. However, after the initial shock, the markets quickly recovered and went on to experience a prolonged bull run, with the S&P 500 gaining over 25% in Trump's first year in office .

The 2000 U.S. Election The 2000 U.S. presidential election, marked by the controversial Bush-Gore recount, also created uncertainty in the markets. Despite the turmoil, the economy continued to grow, and the market stabilized once the uncertainty was resolved. While there was a short-term dip, the overall economic impact was minimal, and the markets quickly returned to their previous levels once the election results were finalized.

 

Why Long-Term Investors Should Stay the Course

Diversification and Patience For long-term investors, the key to weathering election-year volatility is diversification and patience. By spreading investments across a variety of asset classes, sectors, and geographies, investors can mitigate the impact of any single event, including elections. Moreover, staying invested over the long term allows investors to benefit from the overall upward trend of the markets, regardless of short-term fluctuations.

A study by Fidelity Investments found that investors who stayed invested during election years were generally better off than those who tried to time the market. The study showed that missing just a few of the best trading days in the market can significantly reduce long-term returns.

Focus on Your Financial Goals Instead of getting caught up in the political drama, investors should focus on their long-term financial goals. Whether you're saving for retirement, a child's education, or a major purchase, staying the course and sticking to your investment strategy is more likely to lead to success than reacting to the short-term noise of an election.

While election years can bring uncertainty and market volatility, the long-term impact on the economy is often minimal. By focusing on economic fundamentals, staying diversified, and maintaining a long-term perspective, investors can navigate election years with confidence.

Remember, the economy is resilient, and over time, it tends to grow regardless of who occupies the White House!

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