How Presidential Elections Affect the Markets

Merrill Lynch

Bulls, bears, elephants and donkeys: White House races and volatility often go hand in hand.

PRESUMED FRONT-RUNNERS SHOW sudden vulnerability, candidates written off as long shots surge to the front of the pack, and debates grab viewership numbers normally associated with professional football games. The 2016 presidential race has already offered plenty of surprises. But what could it mean for the economy and the markets—and, ultimately, your financial picture?

While the outcome of this race is, of course, still an unknown, history suggests that the markets respond far better to election processes whose outcomes are more predictable, says Mary Ann Bartels, Head of Merrill Lynch Wealth Management Portfolio Strategy. “This time, we’ve got a lot of uncertainties,” Bartels says. “And if there’s one thing markets hate, it’s uncertainty.” The upshot: Markets could be in for a bumpy ride all the way through the November 2016 election.

Start with the fact that President Obama isn’t running for reelection. Regardless of a president’s party or political leanings, departing two-term presidents create a void that financial markets typically find unnerving, Bartels says.

Since 1928, the Standard & Poor’s 500—a widely watched benchmark of U.S. large-cap companies—has dropped an average of 2.8% in presidential election years that don’t include an incumbent seeking reelection, notes Stephen Suttmeier, technical research analyst at BofA Merrill Lynch Global Research. In fact, of the eight years in a two-term presidential cycle, the final year of the second term—when the incumbent can’t run—is the only one that has averaged negative market returns, Suttmeier says. By contrast, in years when the sitting president is up for reelection, the S&P 500 has averaged returns of 12.6%, he adds. (The average for all years from 1928 through 2014 is 7.5%.)

“It’s the economy, stupid”
Continuity isn’t the only reason markets prefer presidents seeking reelection. They also like incumbents because, as they’re trying to get reelected, they tend to obsess over economic issues and promote market-friendly policies. “Statistics such as unemployment and economic growth are highly correlated with an incumbent being reelected,” Bartels says. Adds Suttmeier, “They’re going to be doing as much as they can to support the business cycle, make things look good and make people feel good, so those people will say, ‘I’m going to reelect this person.'”

Indeed, the two most recent presidents to lose reelection bids (Republican George H.W. Bush in 1992 and Democrat Jimmy Carter in 1980) fell short when rising unemployment and economic stagnation were at the top of voters’ minds. (Democratic challenger Bill Clinton defeated Bush in part by drumming into campaign workers the now-famous phrase: “It’s the economy, stupid.”) But when reelection is off the table, second-term presidents may be more mindful of their long-term legacies, and may push issues that are less immediately tied to economic growth or employment.

Parties and profits
This election cycle, presumed frontrunners have often appeared vulnerable to upstarts, leaving markets to sift through any number of potential economic policies from a remarkably diverse array of candidates from both parties. “From the first days of the campaign, we had some prominent candidates who had no political experience, so we have very little basis to judge how well they would deal with Congress, with the Senate, and run the show,” says George L. Perry, senior fellow in economic studies at the Brookings Institution in Washington, D.C.

Nor does party affiliation offer easy clues about which candidates might help or hurt investments. At least from a market perspective, “the general idea that the Republicans are the party of business and the Democrats are the party of labor is actually wide of the mark,” Perry says. “If this was ever true, it hasn’t been for a long time.” The Dow Jones Industrial Average nearly tripled under Democratic President Franklin Roosevelt, according to a 2014 study in the Journal of Business & Economics Research. And while Roosevelt’s results are bolstered by his more than three terms in office and the nation’s recovery from the Great Depression, other Democrats, including Clinton, were in office during market surges, as were Republican presidents Ronald Reagan and Dwight D. Eisenhower. Republican George W. Bush, whose second term ended with the 2008–2009 financial crisis, saw the Dow drop dramatically during his time in office.

Still, investors in 2016 will be looking carefully at the economic proposals of candidates who emerge as viable choices, Bartels says. Markets might, for example, respond well to proposals from a front-runner to reduce U.S. corporate tax rates, which at the current 39% are the highest in the developed world. “Any movement to make corporate taxes more competitive would be very bullish,” she says.

Other key issues might include proposals to reform and solidify Medicare and Social Security, as well as regulatory relief for businesses.

Statistics aren’t destiny
Of course, presidential races don’t occur in a vacuum, and statistics based on previous elections in no way guarantee what will happen in 2016. Unforeseen developments ranging from faraway wars and coups to natural disasters can easily move markets in unpredictable ways. And markets experience regular ebbs and flows, just like the rest of the economy. “Even if we see a sharp correction of around 10% to 15%, it’s in the context that we’ve had this huge run over the past few years and investors are digesting some of the gains,” notes Bartels.

On the bright side, investors may look forward to a possible “relief rally” in 2017, after a new president takes over. On average, the first year of a new presidential term sees the markets rise by 6%, Suttmeier says. That’s below the 7.5% average for all years (going back to 1928), but still a positive signal that the country has survived its latest election drama intact.

Stay focused on the big picture
For most investors, the best way to prepare for possible market volatility in 2016 is to take a long-term perspective. That means staying focused on your personal goals and on broader economic trends reshaping U.S. and global markets. “The real message is that the stock market is a great place for people to put their money for the long run—and I would emphasize: for the long run,” Perry says.

Bartels points to larger forces holding tremendous potential for markets and investors in coming years. “There are massive, long-term trends that will generate opportunities—and, in some cases, challenges—no matter what happens politically,” she says. “To name just a couple: The digital era, big data, cloud computing and cybersecurity will continue to change the world. And the baby boom generation alone represents a $15 trillion economy3, generating demand for everything from health care to leisure to hospitality. These underpinnings of the economy are not going to change, whoever ends up winning the White House.”

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