How election years affect the stock market (a look through time)

In the midst of an election year, the stock market often becomes a focal point for investors. The stock market during election years often does behave differently, and it may experience increased volatility. Current events, coupled with the uncertainty of electoral outcomes, can make even seasoned investors anxious about the future. For new investors, this uncertainty can be particularly daunting. However, a bit of historical context and strategic thinking can give you valuable perspective, help you make more informed decisions, and give you confidence during election years.

Here’s what we’ll cover:

• Historical stock market performance in election years
• Impact of major political events on the stock market
• Common market themes during the election cycle
• Factors that influence election year market performance
• How to think like an investor this election year

Looking back at stock market performance in election years

Historically, the stock market has shown distinct trends during election years. The S&P 500, an index that’s commonly used as a benchmark for U.S. equities, provides a useful reference for election year stock market history. Since 1952, it’s shown an average gain of 7% during election years. For comparison, the average annual stock market return is 10%, and this historial return is averaged over several decades. 

Investors should take note, however, that the average performance of the stock market in election years doesn’t reflect volatility and variation within different election cycles, which can be significant.

For instance, the 2008 election year, in which Barack Obama won the presidency, was marked by a global financial crisis and saw the S&P 500 plummet nearly 38%. In 2016, the stock market recovered from a difficult start in 2016 to end the year on a high note, with the S&P 500 up by 9.5% despite a tumultuous election year that led to the surprise victory of Donald Trump, 

When global upheaval coincides with an election year, the stock market can be even more unpredictable. Case in point: the 2020 election, conducted amid the COVID-19 pandemic, was marked by tremendous market volatility. The “coronavirus crash” saw steep, rapid declines in stock prices in March 2020, but many investors were surprised to see the economy begin to rebound the following month, and the S&P 500 ended the year up by 15.6%.  

The impact of major political events on the stock market

Election years aren’t the only time that major presidential shifts can make waves in the stock market. Rare and shocking events like assassinations and resignations can have immediate impacts, but their long-term effects can be difficult to predict. Three examples from the 20th century underscore the complex interplay between politics and market performance:

• The JFK assassination: When President John F. Kennedy was assassinated on November 22, 1963, it triggered a stock selloff that dropped the S&P 500 by 2.8% before the New York Stock Exchange (NYSE) closed less than two hours later. But within a few days, market performance shot back up, with the S&P 500 gaining 4.3% the Tuesday after Kennedy’s death.  
• LBJ’s no-run decision: The public was stunned in March, 1968 when incumbent President Lyndon B. Johnson announced that he would not seek re-election. But investors took the surprise in stride with a stock market rally that sent the S&P 500 climbing by 2.5%. 
• Nixon’s resignation: In August 1974, sitting president Richard Nixon announced his resignation amidst the Watergate scandal and impending impeachment. Concerns about the transition of power, coupled with rampant inflation, drove a 6.5% drop in the S&P 500. And the impact lasted, with stocks 20% lower five weeks after the resignation.   

While election year stock market history can provide insight into how political uncertainty can dovetail with investor uncertainty, it’s worth noting that political events can feed market changes at any time, and in unpredictable ways. 

Common market themes during the election cycle

When looking at the relationship between election years and stock market history, it may be helpful to step back and look at the entire election cycle. These days, presidential campaigning often begins well before the start of an election year, stirring up speculation about what changes may come in the future. And keep in mind that elections happen in November and winners aren’t sworn in until the following January. That means that the effect of election outcomes often persists well into the next year.  

Pre-election year trends

As presidential campaigns get underway, media focus often turns to the political landscape. This may begin even before the actual election year, as candidates begin making headlines with speeches, policy announcements, and campaign ads. During the election year itself, this activity gathers steam, and the stock market often experiences heightened volatility. Investors grapple with uncertainty regarding potential policy changes and their implications for various sectors. Historically, this period sees increased trading volume as market participants adjust their portfolios in anticipation of different electoral outcomes.

Post-election year trends

Following an election, the stock market typically goes through an adjustment phase. When looking at election year stock market history, it’s common to see rapid, sometimes large shifts in the S&P 500 right after election day. These initial reactions can vary widely based on the perceived impact of the new administration’s policies. However, markets often stabilize as investors gain clarity on the political landscape. And once an elected president takes office in January, ambiguity about the administration’s economic plans tends to fade. On average, post-election years have shown positive returns, reflecting increased stability and improved investor sentiment.

Midterm election year trends

While many investors are concerned about the stock market during presidential election years, congressional elections can also influence market behavior. Midterm election years, which occur midway through a four-year presidential term, generally see less volatility compared to presidential election years. S&P 500 historical data shows below-average performance in the months leading up to a midterm, followed by overperformance in the year after the election. This may be attributable to the shift from uncertainty to clarity before and after the election. But some experts also believe that the overall health of the economy plays a larger role than midterm election results when it comes to how stocks perform in midterm election years. 

Elections can generate a lot of noise and short-term market volatility, especially in the polarized political landscape we’ve seen in recent years. Headlines distract from sound investment decisions.  The best advice is always to focus on a long-term investment strategy that prioritizes growth and diversification. – Doug Feldman, Chief Investment Officer at Stash

Factors that can influence election year market performance

Market performance during election years can be significantly influenced by a variety of factors. An election necessarily introduces uncertainty into the public sphere: investors aren’t sure which candidate will win or what economic changes may ensue. Political instability, potential policy changes, shifting voter sentiment, and changing economic conditions can all create fluctuations in investor confidence and market volatility. 

Political uncertainty and market volatility

Market volatility refers to how quickly and how radically stock prices shift over time. The stock market’s performance always fluctuates to some degree because stock prices are driven by supply and demand. But during some periods, volatility may be particularly high due to investor sentiment, prompting large swings in stock market performance.    

Political uncertainty can be a significant driver of market volatility. That may be why election year stock market history tends to reflect a larger degree of stock market fluctuation. Investors often react to the potential for policy shifts, regulatory changes, and geopolitical developments with increased trading volume. The days surrounding an election may show particularly high short-term volatility as market participants adjust their strategies. For example, the Dow Jones Industrial Average, one of the most widely-referenced market indexes, declined dramatically on election night in 2016, and the election’s surprising results set off a wave of panic selling.      

Investor sentiment and behavioral factors

Investor sentiment plays a crucial role in market movements during election years. Both fear and optimism can drive investors’ behavior, often leading to overreactions. For instance, fears of economic instability or optimism about pro-business policies can result in significant market swings. Investors might start selling or buying securities at a faster pace, or they may be hesitant to invest in certain economic sectors. Human psychology is a factor in stock market performance; investor sentiment isn’t always governed by pure reason, especially when people are unsure about the future. When the news is packed with speculation and opinions during an election year, investors may be more prone to making emotional decisions. 

The effect of investor sentiment on the market is compounded by herd mentality, when investors react to the general tenor of public sentiment. For example, a recent survey revealed that 57% of investors are anxious about the 2024 presidential election and 40% expect to move investments based on the results, despite the fact that both the S&P 500 and the Dow Jones Industrial Average have frequently shown record performance this year.  

How to think like an investor this election year

As another election looms in 2024, you may be wondering how to manage the sense of uncertainty about your investments and whether any volatility that the political landscape injects into the stock market. It may be reassuring to recognize that looking at election year stock market history shows positive performance on average. That said, you may still see market fluctuations or worrying opinions about the state of the economy. But if you keep yourself focused on long-term investing instead of indulging knee-jerk reactions, you can implement strategies that help you stay on course with your financial goals. 

Invest regularly

One of the most effective strategies during election years is to continue investing regularly, regardless of market conditions. Dollar-cost averaging (DCA) is a technique that involves investing a fixed amount of money at regular intervals. This approach helps mitigate the impact of market volatility by averaging out the purchase price of your investments over time. Setting up a DCA strategy can be as simple as automating your investments and choosing a consistent schedule that aligns with your financial goals.

Diversify your portfolio

Diversification is a way to manage risk by not putting all your eggs in one basket: if one kind of investment loses value, others may hold steady or grow, protecting the value of your portfolio overall. By spreading your investments across different asset classes, sectors, and geographies, you can reduce the impact of election-related volatility on your portfolio. Consider taking time to review your portfolio and diversify your investments, including a mix of stocks, bonds, and alternative investments to create a well-balanced portfolio that can withstand market fluctuations and give you peace of mind during election season.

Focus on the long term

Long-term investing is all about time in the market, not timing the market. That means choosing investments you expect to grow over many years instead of trying to predict short-term ups and downs. Election cycles may give rise to many short-term market movements that can be unpredictable and driven by temporary factors. By focusing on long-term goals and avoiding impulsive decisions based on election outcomes, you may achieve more stable and sustainable returns over time. Remember that the stock market has historically trended upward over the long run, despite periodic volatility.

“At Stash, we always emphasize that it’s about “Time in the market, not timing the market.” This holds true even during election years when volatility may spike. Avoid reacting to short-term fluctuations. Instead, focus on ensuring your portfolio remains diversified according to your risk profile, and regularly monitor it regardless of current events.” – Doug Feldman, Chief Investment Officer at Stash

Stay informed, and also stay the course

Burying your head in the sand until the election’s over probably isn’t reasonable, or even possible. Staying informed about election developments can be important, but it’s equally crucial not to make reactive investment decisions. Focus on filtering out noise and concentrating on relevant information that aligns with your investment strategy. Avoid being swayed by sensational headlines or alarmist social media trends that drive emotional decision-making. Instead, base your investing choices on sound financial principles and thorough research.

How to invest in the stock market during election years

Looking back at election year stock market history reveals that political change can certainly cause volatility, but the market tends to calm down after a storm of uncertainty. As you ponder your investing strategy for the election year, consider the benefits of taking the long view. Investing regularly, diversifying your portfolio, focusing on long-term goals, and staying informed without overreacting can help you manage risk and reduce your anxiety amidst the chaos of political campaigns and media coverage. Remember, the stock market has weathered many elections, and maintaining a disciplined approach can serve you well in achieving your financial objectives.

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Election year stock market FAQs

What happens to the stock market in a presidential election year?

The stock market often experiences heightened volatility and uncertainty, but historical trends show a general tendency for positive returns in election years.

Is the stock market more volatile in an election year?

Yes, the stock market tends to be more volatile in election years due to political uncertainty and investor reactions to potential policy changes.

What was the best year in history for the U.S. stock market?

The best year for the U.S. stock market was 1954, when the S&P 500 gained approximately 44% following the end of the Korean War and strong economic growth. There was no presidential election this year, but there was a midterm election. 

Does the election affect stocks?

Yes, elections can significantly affect stocks due to anticipated policy changes, regulatory shifts, and overall political uncertainty impacting investor sentiment.

The post How election years affect the stock market (a look through time) appeared first on Stash Learn.