Analyzing the Impact of Elections

Election seasons are always filled with uncertainty and change — two of the largest drivers of market volatility. As the market tries to understand the impact of future policy changes, it can waver until a) the election is decided and b) the effect of potential new policies on corporate earnings are well understood.

Now that Joe Biden has been declared President-Elect investors of all political affiliations want to know what it means for their portfolios. Obviously, anyone setting out to answer this question cannot predict the future. However, we can look back historically at previous market results after presidential elections to understand the potential impact on portfolios. Armed with this information, we hope to provide investors with perspective on what to expect from the markets in the coming months and years.

Market Returns By Party Structure

As you can see from the illustration above, a historic view of average annual returns from various administrations, shows that the stock market tends to do best under Democratic presidents, and Republican Congresses. At this point we know that we have a Democratic White House, however with the Georgia Senate race still outstanding it is less clear what party will take the majority in Congress. The Congress majority does play a large role in markets because they have more direct impact on the policies and legislatures that can have an effect on industry.

“Red Senate” or the “Blue Wave”

There had been a lot of talk going into the election of the prospect of a “Blue Wave.” Polling estimations predicted that Democrats would sweep both the legislative and executive branches by a wide margin. In terms of of party control, a “Blue Wave” power balance has historically been our most common, making up 40% of administrations going back to 1933.¹ In trying to make sense of the impact of the Blue Wave, it’s prevalence throughout history presents a challenge. Democratic administrations have presided over so many historically adverse market environments (i.e. WWII, currency crises, and the 2008 financial crisis) that it makes it difficult to identify the unique properties of the “Blue Wave” that may drive markets in the future.

Interestingly, there is something missing from the previous table — the permutation of a Democratic President, a Democratic House, with and a Republican Senate. The reason it is missing is because it hasn’t happened since 1886,² and the current power balance we may experience, pending the last results of the Senate race in Georgia. Since we have not witnessed this configuration in the past 134 years, it is difficult to say what this nuanced change in political balance will mean for the markets.

Looking at the potential outcomes of this election, the country finds itself in a strange position. One outcome is so common that it isn’t very telling — and the other so rare that we can’t look to history to attempt to understand. Unfortunately, this isn’t the first time that investors find themselves in a difficult position to measure the impact of global events on the market, and why we suggest that investors don’t even try. Instead, they should be focusing on managing risks across a variety of outcomes rather than attempting to make predictions.

Party Control of the Presidency and Congress, 1933-2020

Putting Away the Crystal Ball

As we have written before, even the best of experts are often wrong. For example, this can been seen in the polling error of the past two elections. In both cases the reality was quite different from what the experts had expected. Forecast error is not isolated to the political world. It is not uncommon for financial market experts to confidently present forecasts that are ultimately proven wrong, only after they have lead investors down the wrong path. At the end of the day it is simply hard to escape the fact that nobody can predict the future.

“All models are wrong, but some are useful”
. – George E. P. Box (Famous Statistician)

About Blue Square

At Blue Square, rather than trying to predict the future, we aim to prepare for it, regardless of its direction. Using our proprietary technology and rules-based approach to investing, our decisions are not swayed by predictions or emotions.

Our investment strategy has a risk management focus that aims to position portfolios defensively during significant market declines. By systematically raising cash during these periods and then investing it when markets are more accommodating, we aim to create a less volatile investment experience, and ultimately deliver better risk-adjusted returns over full market cycles.