The Election is Over: Looking Ahead to the Future

Introduction

The recent election might have gone unnoticed by many, but voters did take to the polls to cast their ballots. While it wasn't a presidential election or a midterm, where control of the House and Senate are at stake, it was still an important event. Various positions, such as city council seats and judgeships, were up for grabs in different states.

Analyzing the Results

Though the majority of the votes were for low-stakes positions and propositions, there were exceptions that have sparked discussions about their potential impact on the upcoming presidential election. It appears that protecting the right to abortion was important to voters, demonstrated by Ohio's decision to enshrine it in its state constitution. Moreover, it was evident that a Democrat can hold the governorship even in a traditionally red state, as demonstrated by Kentucky's outcome. On the other hand, Virginia didn't lean towards the Republican party, which dealt a blow to Gov. Glenn Youngkin and his presidential ambitions.

The Main Event Yet to Come

Nevertheless, all these results merely serve as a sideshow compared to the forthcoming main event. In approximately one year, the presidential election will take place. The anticipated face-off will likely be between the current President Joe Biden and former President Donald Trump, despite neither candidate generating significant excitement amongst the public. Concerns about Biden's age and Trump's legal troubles were reflected in a survey conducted by NBC News and cited by Deutsche Bank. However, these concerns are unlikely to alter the course of events as Deutsche Bank's Brett Ryan notes, "Despite major concerns with candidates, the American electorate is likely to see a rematch of 2020."

Impact on Financial Markets

Historical data from Goldman Sachs reveals interesting trends in the stock market leading up to presidential elections. Over the 12 months before a presidential election, the S&P 500 has recorded a return of 7%, slightly lower than the 9% average for other years. Looking back to 1984, the returns have been even less favorable, standing at just 4%. This is largely due to recessions that coincided with the 2000, 2008, and 2020 elections, contrasting with an average return of 11% in non-presidential election years. Even when excluding these recession periods, returns in presidential election years still fall two percentage points lower in comparison.

The Impact of Presidential Elections on Stock Market Performance

The stock market is no stranger to volatility, especially during presidential election years. However, a closer look at the data suggests that these fluctuations have little to do with the candidates or the election process itself. Instead, the market's behavior can be attributed to uncertainty and investor sentiment.

Historical data shows that the S&P 500 tends to experience a loss of 0.44% on average from January to the run-up to Super Tuesday primaries in March. Additionally, the month leading up to Election Day sees an average monthly loss of 1.27%. However, once the election is over, the S&P 500 averages a monthly gain of 1.28%, indicating that markets quickly stabilize once election year uncertainty is resolved.

While it may be tempting to attribute these trends to specific candidates or polling results, it is important to realize that such factors have minimal predictive value until the final 300 days prior to an election. Therefore, current poll numbers should not be regarded as reliable indicators of market performance.

Contrary to popular belief, the returns generated during presidential election years are not a response to any fundamental changes in the economy. In fact, the U.S. economy has consistently grown at a rate of 3.5% during these election years, compared to 2.7% in other years since 1984. Similarly, S&P 500 earnings per share have grown by 9%, outperforming other years by 1.5 percentage points. This indicates that election-year equity returns are primarily driven by profit growth rather than political variables.

So why do we observe poor returns during the pre-election period? The answer lies in the uncertainty factor. Prior to a presidential election, the S&P 500's price/earnings ratio typically declines by 2%, and the 10-year Treasury yield tends to fall by a median of 0.39 percentage points. As a result, the equity risk premium widens, as investors demand greater yield over safer government debt to hold stocks. Additionally, volatility levels are higher during these election years.

While the stock market may experience fluctuations in response to uncertainty, it is crucial to remember that this is a temporary phase. Polls will shift, opinions will diverge, and the market will react accordingly. However, as history has shown us time and time again, the market will ultimately continue on its upward trajectory.

In conclusion, presidential elections undoubtedly introduce a level of uncertainty into the stock market. However, it is important to separate the noise from the underlying trends. By focusing on profit growth and long-term fundamentals instead of political dynamics, investors can navigate election years with confidence.