Markets and Elections – A Historical Look
Investing in Election Year Markets
Presidential election years are unique to say the least, and this election year is shaping up to be like no other. The impact that elections can have on markets and investor portfolios can be significant. In this installment of Investing in Election Year Markets, we take a historical look at how markets have behaved during these cycles.
Since the beginning of traded securities markets and politics, there has been debate about the interaction between the two. In the late 1960’s, the debate coalesced into the first of many mathematically-based theories that attempted to assign cause and effect to the patterns of market movements during various years of presidential terms. One of the first formal proposals was the “Presidential Election Cycle Theory” developed by Yale Hirsch suggesting that the third year of a presidential “cycle” was the best performing year. Since then, studies have proliferated and it is not clear if there is an actual full cycle trend, or if there is a real difference between Democratic or Republican administrations.
The table is set for a lot of noise, but not a lot of real action. A recipe for continued uncertainty.
We take a narrower slice of time, just the election year itself, and look at market performance recently. We also share some ideas on prospects for different sectors in the future under a presidency by either of the likely nominees (Hilary Clinton and Donald Trump).
The markets have been volatile so far in 2016 and we entered the seasonally weak period for equities in May. In late July, the party nominating conventions will take place, then the actual presidential race will begin. Between now and the end of the year, Congress will do little except for political positioning. Positioning and “message” legislation can add uncertainty to markets as outlandish proposals by both parties garner headlines and even preliminary votes, but with no chance of actual passage. The table is set for a lot of noise, but not a lot of real action. A recipe for continued uncertainty.
Within the actual election year, we see a trend that seems to reflect an uncertainty premium before the election and an improvement in trend after the election, especially if the economy is not in a recession.
The Market Likes Certainty—Large Cap Returns in Election Years
Weekly Data 1988 to Present (S&P 500 Index)
In the chart below, we trace the path of the S&P 500 on a weekly basis for each presidential election year back to 1988. The line at 45 weeks is approximately when the presidential election occurs. An interesting outlier is 2000, which was the year President George W. Bush was first elected. His election was contested, and there was no certainty until a Supreme Court decision on December 12—the 50th week of the year.
Source: Bloomberg data, Guggenheim
Small Cap Stocks Mirror the Post-Election Trend
1988 to Present (Russell 2000 Index)
While large cap stocks have performed well, in general, in the last weeks following the election, so have small cap stocks.
Source: Bloomberg, Guggenheim WRG analysis
Small Cap Stocks Outperform Large Cap Stocks in Most Election Years
1988 to Present (Russell 2000 v S&P 500)
Finally, following the election, small cap stocks tend to outperform large cap stocks. Given the higher beta of small cap stocks, it is not surprising that they should outperform in an environment where the direction of the trend has changed to a positive one.
Source: Bloomberg, Guggenheim WRG analysis
Year 1 Performance—Better than Average Since 1980
We found that the first year after the election, “Year 1” of the new political cycle, has generated higher average and median returns—both for large and small cap stocks:
Price Appreciation by Year of Election Cycle-Large- and Small-Cap Indices. Year 1 Wins
Source: Bloomberg data, Guggenheim
Larger Policy/U.S. Macro Trends
Breakdown: Trump vs. Clinton
We have fast-forwarded the tape to the most likely general election matchup (Trump v. Clinton) and identified the potential implications for both scenarios using a standard breakdown by industry sector. In our minds, there are three potential election outcomes:
This is entirely based off of Washington policy and we do not have an opinion on the fundamental value of the securities in these sectors, but this election has some substantial investment implications given the wide spread in potential outcomes. Here are some very broad sector implications that we see:
- The Trump sector allocation: Positive for consumer discretionary, energy, industrials, information technology (IT), materials, and telecom services; Negative for consumer staples and healthcare; and Neutral for financial services and utilities.
- The Clinton sector allocation: Positive for industrials, IT, materials, and utilities; Negative for consumer discretionary, energy, and telecom services; and Neutral for consumer staples, financials, and healthcare.
- The sectors that could benefit regardless: industrials, IT, and materials.
Potential Impact on Senate
Barring a total Trump disaster, the House should stay in Republicans’ hands given their 29-seat majority and lack of competitive/swing seats. The Senate is essentially a jump ball with the winner of the White House likely to bring the Senate along for the ride. The Senate is currently GOP-controlled 54-46, though 24 of the 34 seats up this cycle are Republicancontrolled and seven of them are in states Obama won twice. The GOP is only really playing offense in Nevada and is unlikely to lose both Illinois and Wisconsin. The key Senate races are in the key Electoral College states (New Hampshire, Ohio, Pennsylvania, Missouri, North Carolina, Florida), which means whoever wins the White House has highly likely won by winning those states.
Potential Impact on Policy/Legislation
As far as we can discern, Trump only has two pronounced policy “red lines”: 1) building a wall on the southern border (bullish for materials sector), and 2) tariffs on China-made products (bearish for consumer staples via the dislocation of the global supply chain). Outside of this, Trump has maximum policy flexibility. From a market standpoint, we would expect sentiment around a GOP Presidential win to be positive and led by the energy sector given regulatory shift and legislation on development (increased drilling) and pipeline siting (direction from pro-energy GOP Congress versus a Trump Administration that is an open question on energy policy). With a Republican White House win, GOP control of Congress is highly likely, which means the ability to pass tax reform and Obamacare reform/repeal through the reconciliation process. For healthcare investors in the GOP sweep scenario, the main question is if they will really repeal and replace—an outcome that is unclear and would completely upend the sector. Telecom and cable would likely welcome GOP control by removing various forms of broadband regulation imposed by the Democratic Federal Communications Commission. Franchises and restaurants would also likely welcome a GOP sweep as the Joint Employer Rule could be reversed. M&A could increase with more market-friendly regulators at the Department of Justice and Federal Trade Commission. With a Clinton Presidency, we would expect investors to be wary of prescription drug control measures, though note that there would still be a policy "put" with the House in GOP hands. We suspect that immigration reform and an infrastructure plan would be central to Clinton’s first 100 days, which would be positive for materials and IT.
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2016, Guggenheim Partners.
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