It's Election Day! What Does That Mean for Markets? - Root Financial

It’s Election Day! Every two years the US House of Representatives and one-third of the Senate is up for reelection.

While the outcomes of these elections are uncertain, we know there will be no lack of opinions in the days to come.

In financial circles, this will certainly include opinions as to what the election results mean for the stock market. But should long-term investors focus on midterm elections?

I looked at 92 years of data to find out! Here’s what I saw –

Markets Work

Markets work. Here’s what I mean by that – Think of the stock market as an incredibly powerful information-processing machine.

Every day millions of investors place billions of dollars worth of trades. Every single one of these trades reflects the information and expectations of these investors.

But what does this mean practically?

It means if there’s a clear-cut expected winner in a certain election, then these investors have taken that information into account when making trades and it is already reflected into stock prices today.

This makes it difficult to consistently outguess market prices. And while surprises can and do happen in elections, the surprises don’t always lead to obvious outcomes for investors.

The 2016 presidential election serves as a recent example of this. There were lots of opinions about how the presidential election would impact markets, but many articles at the time assumed stocks would fall if Trump were elected.

But the day following President Trump’s win the S&P 500 Index closed 1.1% higher. So even if an investor correctly predicts an election outcome, there is no guarantee they could also predict how that would impact the stock market.

But what about congressional elections?

For these midterms, market strategists and news outlets have given their opinions on who will win and what impact it will have on markets.

However, data for the stock market going back to 1926 shows that returns in months when midterm elections took place did not tend to be that different from returns in any other month.

Exhibit 1 shows the frequency of monthly returns (expressed in 1% increments) for the S&P 500 Index from January 1926–August 2018.

Each horizontal dash represents one month. And each vertical bar shows the cumulative number of months for which returns were within a given 1% range (e.g., the tallest bar shows all months where returns were between 1% and 2%).

The blue and red horizontal lines represent months that a midterm election was held. Red means Republicans won or maintained majorities in both chambers of Congress, and blue represents the same for Democrats.

Purple boxes indicate mixed control, where one party controls the House of Representatives, and the other controls the Senate. Gray boxes represent non-election months.

This chart shows that election month returns were well within the typical range of returns. It didn’t matter who won the election (from a stock market standpoint).

Exhibit 1: Midterm Elections and S&P 500 Index Returns

Histogram of Monthly Returns, January 1926–August 2018

In It for the Long Haul

While it can be easy to get distracted by month-to-month or even year-year returns, what really matters for long-term investors is how their wealth grows over longer periods of time.

Exhibit 2 shows the hypothetical growth of wealth for an investor who put $1 in the S&P 500 Index in January 1926. Again, the chart shows who controlled Congress over time.

During this time, both parties had periods of significant growth and significant declines during their time of majority rule.

However, there does not appear to be a pattern of stronger returns when any specific party is in control of Congress, or even when there is mixed control.

Historically, markets have provided strong returns over the long run regardless of (or perhaps in spite of) which party is in power at any given time.

Exhibit 2: Hypothetical Growth of $1 Invested in the S&P 500 Index and Party Control of Congress

January 1926–August 2018

Take Away

We invest our money today because we believe that doing so will help to grow our assets over time.

Trying to make investment decisions based on the outcome of elections is unlikely to result in superior returns. You could always get lucky, but the mistakes could be costly if you’re wrong.

So get out there and vote! Your vote matters. Just don’t expect it to impact the value of your investments over time 🙂