How the Stock Market Responds to and Predicts Presidential Elections
The most powerful person in the world is chosen by the U.S. presidential elections every four years. The United States of America is a world leader whose actions, to a degree, affect just about every other country in the world - so its elections are closely watched not just by U.S. citizens, but by people all over the globe. The results of presidential elections affect many outcomes: public policy, international relations, and the direction that the country takes in the following four years. But how exactly do presidential elections affect the stock market? And how has the stock market been used to predict the outcomes of future elections?
How the Stock Market Responds to Election Outcomes
Analysis of public market indices has shown that in the 12-month periods leading up to election years, the market underperforms slightly. In any 12-month period over the last 90 years, public equities have returned an average of 8.5%, but in the years leading up to a presidential election, the average return was just under 6%. Market volatility also increases in the year leading up to an election.
Industry-specific effects are seen after presidential elections, especially when candidates run on the platform of subsidizing certain industries, reducing or increasing industry-specific regulations, or otherwise granting or taking away an advantage to a given industry.
Stock prices for companies within industries that rely on foreign trade may rise after the election of a candidate seeking to decrease tariffs, or conversely fall after the election of a candidate who wants to increase tariffs.
Short-term volatility occurs when a political party gains full control over the House of Representatives, the Senate, and the White House. This is because a political party having full control over the government signifies the coming of public policy change that will likely disrupt many industries. When no party has full control over the government in this way, political gridlock ensues and sweeping effects on the market are less likely to occur, leading to less volatility as a result of this outcome.
With few exceptions, the stock market (S&P 500) has always increased in value over presidential terms, no matter which party wins the presidency:
All else held constant, over the past 90 years an incumbent president returning for a second term yields higher stock returns than does a new president entering office:
International stocks are affected less by U.S. presidential election outcomes than stocks of U.S. companies are. However, some factors that U.S. presidential election outcomes may dictate that directly affect international stocks include: geopolitical tensions, trade policy, international relations, and the relative strength of the U.S. dollar.
How the Stock Market and the Economy Can Be Analyzed to Predict Elections
In the last 100 years, every president who avoided an economic recession was reelected. Calvin Coolidge was the only president who was reelected when there was a recession within two years of the presidential election.
What most people are referring to when they say that “the stock market predicts election outcomes” is the following phenomenon. The performance of the S&P 500 in the three months before votes are cast has predicted 87% of elections since 1928 and 100% since 1984. When returns on the S&P 500 were positive compared to the price 3 months prior, the incumbent party won the election, whereas when returns were negative, the incumbent party lost.
This year, the S&P 500 was down 0.6% from three months prior, thus once again predicting the outcome of the presidential election.