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I was too busy packing for my post-election move to Canada to get out an update in October, but no worries – the recovery continues to trundle along and there was nothing of particular note in the economic news last month. Mostly more of the same, with a slight tilt towards an acceleration in the recovery, as data showed GDP growing a a faster pace than it has been and signs that inflation may be picking up.
I know that many Thrift Savings Plan investors are very nervous about the presidential election and its potential impacts on their nest eggs, particularly given the string of down days we have had over the last week and a half. So today’s update is all about the election. Don’t worry, this is a strictly non-partisan webpage and there won’t be any political views. Please don’t mistake anything I write below as favoring one candidate over the other.
Today I will cover: (1) what is causing that losing streak, (2) how the markets typically react to elections, (3) whether the stock market predicts election results, and (4) what I think is going to happen over the next week and through the end of the year.
Longest Losing Streak since 2008
Everyone has been so distracted by politics that almost nobody has noticed the S&P 500 has fallen eight days in a row. That’s the longest streak since the Financial Crisis. If we hit nine down days in a row that will be the longest losing streak since 1980.
It all sounds very dramatic, but the fact is that it has been a very mild decline, falling just 2.9% in that period.
So what caused the drop? See number 1 in the section below.
Elections Impacts on the Stock Market Historically (the good old days)
Take it with a grain of salt if someone marks up old stock market charts to show when elections occurred and tries to draw conclusions. Remember that the market is continuously evolving and looks nothing like it did 25 years ago, much less 100 years ago. And remember that there were a lot of other things going on impacting the market besides the election (most notably the business cycle, which really couldn’t care less who is in the White House). It is also very easy to cherry pick data so you get the result you want – for example I can convince you that either Republican presidents or Democrat presidents are better for the stock market by just switching which index I’m using or using a slightly different date range.
But for what it is worth, here are some nuggets from history:
(1) The number one lesson is that the market responds much better to elections where the outcome is predictable. That makes sense, because if there is one thing the market hates, it is uncertainty. That’s why the market was so steady, trading in a tight range for almost three months as Clinton started to look like a sure thing. But it has been sputtering since Director Comey sent his letter to Congress and Trump came back a bit in the polls. Uncertainty is a self correcting issue, but not until November 8.
(2) There is more uncertainty this cycle because the incumbent isn’t running. Since 1928, the S&P 500 has dropped an average of 2.8% in the final year of a president’s second term. Compare that to the average return of 12.6% in years in which the incumbent is running for reelection.
(3) In years in which the incumbent can’t run, the market does markedly better if the incumbent’s party wins the election than if the incumbent’s party loses.
(4) The market rises an average of 6% in the first year of a presidential term, a little lower than the 7.5% average for all years. The market typically does better in the second half of a president’s four year term than the first, with the last seven months of the president’s last year being positive in all but two election years since 1952.
(5) When you look at what the most successful combination of who is president and who controls congress are, the rankings from best to worst are as follows:
- Democrat President/Republican Congress
- Either party controls both White House and Congress
- Either party in White House/Split Congress
- Republican President/Democrat Congress
(6) And finally, under which party has the stock market done better? There are a lot of different studies out there, most of them coming out with a statistically insignificant advantage to the market under Democrats when corrected for market volatility. And that advantage is so small it is meaningless compared to other normal market return variations. For every study which shows that one party is better than the other, you can change the date range slightly or measure a different index and come out with the opposite result.
Does the market predict the results of the election?
Historically, if the stock market is up in the three months leading up to the election, the incumbent party wins, whereas stock market losses over those three months tend to predict the opposition party will win. In the 22 presidential elections since 1928, 14 were preceded by gains in the three months prior. In 12 of those 14 elections, the incumbent (or the incumbent party) won the White House. In seven of eight elections preceded by three months of stock market losses, the incumbent party lost. That means the S&P 500 has an 86.4% success rate in forecasting the election.
This is an interesting fact, but the folks who crunch numbers for a living will tell you that this isn’t a large enough sample to be at all conclusive and it obviously ignores all of the other factors which go into the stock market and presidential elections.
But just for fun, what does this indicator mean for the 2016 election? A few trading days out from the election, that measure is too close to call. Over the past three months the S&P 500 is down 0.73%. It can change that much in a few minutes, so unless something changes in the next few days, the market won’t be making a strong call one way or the other on this one.
The Crystal Ball
There are three possible outcomes: clear Clinton win, close call either way, and clear Trump win.
Clinton Win: My prediction is that Clinton wins with a large enough margin in the Electoral College that there is no dispute and nobody calls for statewide recounts in the presidential race, followed by Trump conceding more or less gracefully. If you go back just a few months, you will see that I was wrong about which way the BREXIT vote would go, and it is entirely possible that I will be just as wrong here as well.
I don’t think the election is as close as the media wants you to think it is. CNN will make over a billion dollars in ad revenue on its election coverage over the past 18 months. They don’t keep people tuned in by saying it is all-but-over if you look at the electoral college numbers. They get you to watch commercials by putting up tickers showing the results of some poll which doesn’t really tell us anything about the actual election.
The impact of a clear Clinton win would be the market breathing a sigh of relief to the upside, and I think we would see a few percentage point gains between now and the end of the year.
A Hanging Chad: The next most likely alternative is a close election, with either Clinton or Trump winning. Both parties have armies of lawyers standing by in each of the swing states, so if they are separated by just a few electoral votes I don’t think we will see either one concede on November 8. That would be fantastically stressful for the stock market (see above where we talked about how the market hates uncertainty), and I would expect to see the market move lower until the results become clear, at which point we will see a recovery. If I thought this was likely, I would move to the G Fund until the drop and then buy the C Fund back at a lower price.
Trump Wins: Finally, and least likely in my estimation, is a clear Trump victory. The Republicans just start with too deep a hole in the electoral college to make mistakes, and Trump doesn’t appeal to a broad enough swath of Americans to overcome that disadvantage. But just as with BREXIT, I could be wrong, and Trump could become the President-elect on November 8.
If that occurs, I believe we would see a fairly sharp market correction as all the experts who were quite certain Clinton would win see themselves caught on the opposite side of the bet. I would expect the correction to be between five and ten percent. And that would be a very good buying opportunity, because (just as with BREXIT) it would quickly become apparent that the world would not end and that the President doesn’t actually have much control over the economy. So I expect the market would recover relatively quickly and the market would end the year about where we are now or perhaps just a bit lower. As with the Hanging Chad possibility, if I thought this were likely I would move to the G Fund and buy back in at a lower price after the drop.
As I mentioned before, this is a strictly non-partisan blog and the predictions I made aren’t based on any political views I hold, just what I think will happen based on what I have read. So please don’t unsubscribe if I predicted the team you are pulling for might lose.
So what does that all mean for me?
As with the vast majority of “THE MOST IMPORTANT THING EVERs”, I don’t think the election will impact the economy over the short or medium term. So I am staying exactly where I am and not changing my allocation. The next week will almost certainly be volatile, but that only affects me if I sit and stare at CNBC all day. Over the long term, I believe this is just going to be a little flat spot on chart which otherwise points up at a very nice angle.
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