How the Election Should Impact the Markets

Between now and November, it is safe to say we will all hear a lot about the elections. News sites will publicize and analyze every word the Presidential candidates say. Commercials will fill the minutes between shows on almost every channel. Whether your favorite shows are on PBS or Cartoon Network, it’s unlikely you’ll be able to avoid hearing about the election.

For most of us, this election will actually have an important impact on our lives. This is especially true for investors since news over the next few weeks is likely to impact stocks, bonds and in some ways, our personal wealth.

Stocks do seem to react to elections. Investors often hear about the Presidential Cycle in the stock market. The theory is that politicians will say almost anything to get elected. Once they are in office, they take action quickly, ignoring the stock market to do what’s needed to get the economy on track. This means the first two years of a four-year term are expected to deliver below average returns while the last two years, the time when the President is thinking about reelection, should provide above average returns. There is some evidence supporting this cycle with Standard & Poor’s finding elections years are more likely to be up than down, but the size of the gain is likely to be below average.

On average, Standard & Poor’s reports stocks move up 76% of the time in election years. This is a little better than the win rate for all years which stands at 71%. In an average year, the S&P 500 gains 8.8% but the average gain in an election year is just 6.1%.

Of course we know averages can be deceiving and that is true in this case. If we dig deeper we discover the gains in election years are actually better than average at 9.1% (about 0.3% a year better than the all-years average gain) if we exclude 2008. The question is whether or not we should exclude 2008. It seems safe to say that 2008 was an unusual year with a catastrophic market meltdown. It’s unlikely we will see another event like that so it does make sense to exclude it from this study. Without the large loss from 2008, on average the S&P 500 provides a better than average gain in election years like this year.

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Unfortunately, the path to the expected gains could be rocky. Guggenheim Investments looked at the trajectory of the market in election years and they found there is one unusual year, besides 2008, that stands out. In most election years, investors see prices move steadily higher through the year. In the chart below, 2008 is the worst year but 2000 also shows a loss.

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In 2000, the election for President was between George W. Bush and Al Gore. Bill Clinton had been in the White House for eight years and the economy was strong. Gore was likely to continue Clinton’s policies and many voters wanted that to happen. Bush was the candidate for change and he appealed to partisan supporters at a time when partisanship was increasing according to many measures. It was a close race and 2000 turned out to be a year filled with uncertainty. The winner of the election wasn’t determined until weeks after the election as recounts and legal questions dragged on. Political commentators had known the election would be close because the polls flipped back and forth between the nominees. This was different than what we see in most years where there is a clear frontrunner. The next chart shows polling data from 1996 (on the left), a typical year when there is little doubt as to the outcome of the election and 2000 (on the right) when polling is less clear.

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This year, there isn’t a clear frontrunner and polling data looks similar to 2000 as the next chart shows.

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Polling data reflects uncertainty among voters. There is no clear winner with both candidates consistently polling below 50%. The presence of third-party candidates adds to the uncertainty.

Uncertainty may be a continuous theme for the rest of the year. Even if Mr. Trump were to hold a compelling lead in the polls, many pundits would look for Mrs. Clinton to win on election day because they would discount the accuracy of polls, question the conviction of Trump supporters to actually vote or find some other reason to question the data. If Mrs. Clinton takes a commanding lead, other pundits will note Trump is an unconventional politician and claim he shouldn’t be counted out. Commentators are likely to add to the uncertainty of this election cycle and that makes this year more like 2000 than 1996.

As traders, it’s important to understand the impact the election might have on our finances.

Guggenheim also looked at the positions of each candidates and identified sectors they think will perform well once the outcome of the election is known.

If Trump wins, they believe his election will be positive for stocks in the consumer discretionary, energy, industrials, information technology (IT), materials and telecom services sectors. They believe the consumer staples and healthcare sectors will be losers if Trump wins.

Their analysis indicates materials should gain based on Trump’s promise to build a wall along the southern border. Energy could benefit from a shift in the regulatory environment that could see more drilling and expanded pipeline construction. Telecom and IT could also be likely to benefit from a shift in the regulatory environment with less scrutiny from the Federal Communications Commission. Consumer discretionary stocks include large retailers, restaurants and other franchise-based businesses that could benefit from reduced pressure to increase wages.

To the downside, consumer staples could be among the losers in a trade war with China if Trump follows through on his call for tariffs. When one country imposes tariffs, it’s common to see other countries engage in similar behavior. Tariffs were one of the factors that hurt economic growth in the 1930s with most economists agreeing they contributed to the deep economic decline in the Great Depression.

Healthcare stocks could face uncertain regulations as the Trump White House would be expected to work with what would likely be a Republican Congress to repeal and replace the Affordable Care Act. Until plans for new regulations became clear this sector could fall sharply.

If Clinton wins, analysts at Guggenheim see gains for stocks in the industrials, IT, materials and utilities sectors. A Clinton presidency could hurt the consumer discretionary, energy and telecom services sectors.

While Clinton would continue many current policies, immigration reform and an infrastructure plan would most likely be among the first initiatives undertaken by a Clinton White House. Guggenheim believes these policies “would be positive for materials and IT.”

A Clinton win could lead to continued regulatory pressure on stocks in the consumer discretionary, energy and telecom sectors.

There is some overlap in their analysis. The sectors that could benefit no matter who wins are industrials, IT and materials. There are ETFs available for these trades — Industrial Select Sector SPDR ETF (NYSE: XLI), Technology SPDR (NYSE: XLK) and Materials Select Sector SPDR ETF (NYSE: XLB).

One factor that could boost stock prices would be a dramatic announcement from the Federal Reserve, most likely related to a new easing policy. We are unlikely to see a significant change in Fed policy, since the Fed is not political and has historically avoided actions that could influence the outcome of elections. With the Fed on the sidelines, we should look for stocks to remain in a narrow range or drift lower from their current levels. No matter who wins, three ETFs (XLI, XLK and XLB) appear well-positioned to deliver gains in any market environment.