How Do Stock Markets Perform During A Presidential Election Year?

Key Takeaways

The stock market has been off to a rough start in 2016 and you may be wondering if it's just the beginning of a bear market. A lot is going on in the U.S. and around the world: dropping oil prices, turmoil in China's economy, fears of deflation, and the uncertainty of who America's next President will be in the upcoming elections on November 8, 2016.

Could the Presidential election wreck havoc on an already teetering stock market? Will the position of power turn from Democratic leadership to Republican leadership? Let's take a look at how the stock market has performed before, during, and after Presidential elections to gain some insights on where things could be headed this year.

Historical Trends Toward The End Of Presidential Second Terms

Based on past data, it could be a rough ride in the stock market this year. The S&P 500 has dropped an average of 1.2 percent in year eight of presidential terms since 1900. The worst year was in 2008 at the end of George W. Bush's last year in office when the market was down close to 41 percent.(1)

That was a year you probably remember quite clearly since many people lost their jobs and the nation struggled with high unemployment and the housing crisis. Even the most experienced investors were not immune to the stock market collapse. While those memories might be seared into your mind, you may not have really thought about the fact that 2008 also happened to be the end of Bush's second term.

On a positive note, although 2008 was an election year there were many other forces at work that led to such a dramatic fall in the stock market, which hopefully won't recur – namely, a much tighter credit standard of who can obtain loans. No longer are there No Income No Job (NINJA) loans or Negative Amortization loans that entice people to buy much more house can they afford. Banks have been recapitalized with much higher tier 1 capital ratios per government requirements.

It is also worth noting that even though the S&P 500 was down an average of 1.2 percent during year eight of the presidential terms since 1900, it experienced positive growth in some years. Forty-four percent of the years in that period saw a rise in the S&P 500. Although that data point doesn't convince some analysts this year could see gains in the market, it may offer some investors a glimmer of hope for a recovery from recent declines before the year is over.(2)

Uncertain Times Lie Ahead

Presidents can be a bit unpredictable during their final year of a second term as they come to face their limited time left in office. Unpredictable behavior combined with a lack of consensus of who the next president will be can fuel a lot of uncertainty that can upset the stock market.

Jeff Hirsch, editor in chief of the Stock Trader's Almanac, describes exiting commander-in-chiefs as "lame duck presidents with little political capital left," who as a result "push through policy initiatives by executive orders and any other means possible."(3)

Hirsh also said, "The eighth years of an incumbent's term in the White House have all been pretty horrible for markets with the exception of 1988 when Ronald Reagan was leaving office. And the first five months of an election year are generally very telling. If you've got a down year, that's usually indicative of the incumbent White House party being ousted. That clearly puts a damper on Clinton's prospects. The stock market is a voting mechanism."(4)

Source: CNBC

The fourth year of a president's first term tends to fare much better. Some associate the general trend of incumbents getting reelected as a reason why there is less panic in the stock market during those years as compared to year eight. Since 1900, 83 percent of the time year four of a president's first term has seen an average gain in the S&P 500 of 11.5 percent.

Pre-election years have performed the strongest when looking at four-year cycles, which clearly stand out in the below chart.

Pre-election years have performed the strongest when looking at four-year cycles.

Source: Forbes

Which party is likely to be voted into office during an election year can also affect how stocks perform, especially as the election date approaches. Typically when people believe the incumbent party will get elected, the market goes up. If consensus points towards a new party taking over, however, the stock market tends to go down. Uncertainty and fear can cause increases in volatility compared to feelings of confidence and the familiar.

Certain industries may also be notably affected depending on which party is likely to be voted into office. For example, pharmaceutical companies could experience gains with a Republican taking over since many Democrats want to cap drug pricing. Coal is another industry that might rebound with a Republican in office since they typically are not as strict with air-quality regulations and the industry experienced close to an 80 percent decline in 2015.(5)

Some economists like Ian Shepherdson are hopeful for what could lie ahead. Shepherdson believes, "We are not going to see a big drop in sentiment and when you've got such a big drop in gas prices, that will mitigate the hit quite substantially. Assuming the market stabilizes — and I think it will — most of that extra money from low gas prices will get spent. Market turbulence doesn't last forever, and if you are a Democrat, you might be quite glad to get it over with now and hope that by November everyone will forget about it."(6)

Keep An Eye On The Polls

There's a lot in store for 2016 and it's likely the election could impact the stock market one way or another. Keep an eye on the polls as November approaches. According to the latest betting odds by PaddyPower, Hillary Clinton has the best odds with 10/11, followed by Donald Trump with 4/1 odds, Marco Rubio with 11/2 odds, and Bernie Sanders with 13/2 odds.(7)

Do you have a hunch for which way the election could swing? Create your own custom motif of up to 30 stocks or ETFs to reflect your beliefs. Looking for some ideas to get started? Explore our catalog and open a free account today.

Image Credit: Public Domain

The content contained herein is for informational purposes only and is not a solicitation or a recommendation that any particular investor should purchase or sell any particular security. Motif does not assess the suitability or the potential value of any particular investment. You are responsible for understanding the risks involved with investing in securities and for all investment decisions you make. Investments in small cap companies and companies within a particular sector involve additional risks unique to those companies which you should be aware of before making any investment decision. The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. Performance of motifs are for informational purposes only and is not not based on results you could expect to achieve. See how returns are calculated.