Should an Election Affect Your Asset Mix?

U.S. elections are a powerful force in investor psychology.

In fact, historically, investors pour more money into low-risk assets than equity investments surrounding election season. Following election years, investors reverse course and put their money back into equities.

This Markets in a Minute chart from New York Life Investments shows how investors have reacted to U.S. presidential elections over time, and why maintaining your long-term asset mix may be a better course of action.

Market Behavior During U.S. Elections

While investors allocated funds into safe assets in election years, what happened to the market?

Source: Morningstar (Dec, 2019)

On average, the market has returned 11.3% in election years over the last century.

Markets also appear to prefer familiarity—when the incumbent president won, the S&P 500 averaged higher returns. Alongside this, it made no difference if a Democrat or Republican candidate won.

Implications for the 2020 Election

Still, with mail-in voting controversy and the anticipation of a results dispute, the 2020 presidential run has stoked greater volatility in financial markets. What reference point can we make to previously contested results?

Following the 2000 results between Al Gore and George Bush, investor fear ran rampant. Markets fell 1.6% when no winner was clearly determined. Compare this to the 2016 presidential run, when markets jumped 1% the day after the election.

But while short-term impacts of U.S. elections cause heightened uncertainty, it’s important to analyze if it’s an emotional or rational decision being made in response to market unrest.

Opportunity Costs

While investors typically run to safe-haven assets during these cycles, the table below illustrates how this may be less optimal for their portfolios.

Source: U.S. Treasury (Dec, 2020)

Instead of paying attention to unknown variables inherent in every market, investors can focus on what the numbers are saying.

Building a Resilient Portfolio

So how can investors stay the course during election season?

Broad historical trends show that in spite of unique events, money in the stock market positively increases over time. Staying invested in your long-term asset mix can help capture these overarching trends.

One-off events such as an election provide an opportunity to take advantage of temporarily lower prices. This, coupled with the higher volatility levels that accompany election cycles, offer an avenue for your portfolio to be more resilient as it helps strengthen portfolio returns.

The diminishing returns of cash compound this effect. Over the last decade, cash returned close to 0%. These return rates could fall even lower in the years ahead as interest rates decline.

In short, it’s impossible to predict the future. Instead, equities and other fixed income investments have offered a number of advantages. Macroeconomic factors, such as falling interest rates and the supply of capital, have only highlighted this trend.

This Markets in a Minute Chart is available as a poster.

U.S. Elections: Charting Patterns in Market Volatility

Do elections influence market volatility?

Over 90 years of data shows that volatility jumps 30% in the five months leading up to an election. But while elections have historically stoked uncertainty in the market, in reality, the scale of their impact plays a relatively minor role.

This Markets in a Minute chart from New York Life Investments shows volatility trends surrounding elections over the last century, and how investors can best position themselves amid market turbulence.

Making Sense of Market Volatility

Volatility is when a security has sharp price movements in either direction. The market’s volatility is measured by the CBOE Volatility Index (VIX), also known as the ‘fear gauge’ for the market. The higher the VIX reading, the higher the volatility.

The five-year average VIX value is 15.8, with an an all-time low of 9.1 in November 2017, and reaching an all-time high of 82.7 in March 2020. Specifically, in the five months ahead of U.S. elections, the VIX tends to fall between 14 and 18.

Source: Eureka Report

After the dust settles from elections, market volatility reduces as investors gain more clarity on government direction.

In short, in the six months following an election, volatility tends to fall on a downward sloping trajectory.

Finding Opportunity Surrounding U.S. Elections

With volatility here to stay, investors can utilize a number of portfolio strategies prior to elections.

1. Stay the course: The easiest thing investors can do is nothing. Ignoring irrational market activity and staying invested will help you keep your investment goals on track.
2. Focus on value: Investors can focus on companies with sound balance sheets that return value back to shareholders, such as fixed-income investments or dividend-paying stocks. For instance, when concerns circled around increased taxes on investment income in 2012, no less than 1,100 companies issued a special dividend following the election.
3. Bargain hunt: Overvalued stocks, or sectors in the policy spotlight, can temporarily dip amid market fear. For example, in 2016 the health care sector saw new policies that investors feared would have damaging effects. Ultimately, these concerns were overdone, and the sector rallied after the election.

Focusing on solid company fundamentals can offer windows of opportunity to investors who look past the short-term volatility.

Long-Term Areas to Focus On

Investors can look to structural factors, such as the economic environment, that have a more powerful impact on financial markets.

Interest rates, low bond yields and policy measures, among others, have a greater influence on market performance. Rather than paying attention to short-term volatility, investors can also focus on policy changes that have a lasting impact on the economy:

1. Employment: Economic policies that help to promote workforce outcomes will have positive impacts on earnings growth, market performance, and investor portfolios.
2. Taxes: Tax policies reallocate capital. Corporate tax cuts, for instance, can buoy markets and investor optimism.
3. COVID-19 containment: The policies in place in response to COVID-19, such as the CARES Act, will have a marked impact on investor sentiment, company earnings, and ultimately economic resilience.

Looking past the election, and keeping an eye on policy shifts, could provide more insight into key forces shaping the future of the economy.