Photo credit: AP Photo/Nam Y. Huh
It is perhaps not surprising that stock markets can be more volatile around elections, and, true to form, we’ve seen a rocky market in the lead up to these elections. However, the directional impact of midterm elections for the market is debatable. Some studies have found that the stock market performs better under Democratic presidents, especially for smaller U.S.-based firms. However, this is debated, and further studies have found that the link does not stand up to statistical scrutiny. As such, the idea that the party in power is relevant for the markets is not proven, at least not at the level of the overall market. There is still a debate about how certain sectors of the economy perform under different parties. For example, firms with higher exposure to government spending tend to perform better under Democratic administrations according to the research of Frederico Belo. Nonetheless, it’s not clear that midterm results will have a predictable impact on the market.
Political Business Cycle
There is another electoral theory that has been around since at least the 1970s and may be more relevant. It suggests that politicians stimulate the economy before elections to improve their chances of winning the election, not just in the U.S. but everywhere and regardless of party. It is often referred to as the presidential election cycle, and various studies support its existence. If true, this is good news for stock investors, theory suggests that the first two years of a presidential term can be uninspiring for investors, but the final two years as a presidential contest nears can be more positive. If that’s right, we may have two good years ahead of us.
It’s a theory with logical reasoning behind it and a decent run of historical data spanning decades. However, unfortunately, more recently since George W. Bush’s second term the link between presidential elections and the stock market has had a bad run. George W. Bush’s second term and both of Barack Obama’s two terms saw stronger stock market performance in the first half of the presidential term, than the second. This is the opposite of what theory would predict. Furthermore, Trump’s first two years have seen robust market performance, so he may buck the implied trend as well.
Depending on how 2018 ultimately concludes, the S&P 500 would have to deliver two years of better than 11% annual performance for the second half of Trump’s presidency to outperform the first half of his term from a stock market standpoint. That’s possible, but 11% or better annual returns, though certainly possible, do set a reasonably high bar. Also, with central bank independence becoming a key theme, not just in the U.S. but globally it’s perhaps becoming harder for politicians to manipulate interest rates in their favor, which is one major way to juice the economy for an election. However, Trump does appear to be trying to influence the Federal Reserve, who set interest rates. A further consideration is that the a tax cut was passed almost a year ago, in a sense, that’s far too early for helping a presidential election according to theory, since the relevant presidential election was three years out at that point. We’re also currently looking at elevated valuations and likely further rising interest rates in the U.S. It can often be risky to argue against broad statistical trends with mere anecdotal data, but there are a number of unusual features of the current market and this presidential cycle that suggest the presidential election cycle may be more muted in its stock market impact for 2019 and 2020.
Ballot Measures
One direct impact on the market from the elections will come from the raft of other measures on the ballot. There are 155 statewide measures on the ballot this year. For example, Colorado has ballot measures that would impact payday lending and energy companies. California has an initiative that would impact dialysis providers. Florida has an initiative regarding gambling to pick just a few examples. Multiple states also have ballot measures that would change the rules on marijuana, energy policy or minimum-wage levels. Of course, as expected, there are ballot measures related to many other topics too, with less immediate stock market impact, but as these ballot measures grow in number and creativity, so their stock market impact may rise too.
So there is no clear evidence of how any change in the distribution of political power will impact the markets, and there are good reasons to believe that presidential electoral cycle may not be as strong this time around as at other points in history. However, should certain state-level ballot measures pass, these may well have an outsized impact on specific stocks after the midterms.