Spoiler alert: You are about to hear what effects this year’s Presidential election may have on the U.S. stock market six months down the road. Are you ready? The answer is probably not much. That’s right: a hotly contested election pitting competing economic policies against each other in a time of world financial crisis probably will make little difference to your portfolio. How do we know this? Many academic studies have shown that political events usually don’t have lasting effects on stock prices. Although highly-charged events such as electoral upsets or terrorist attacks or assassinations may jerk prices around for a few days, in the long run market prices are determined by investors’ perceptions of corporate earnings.
Consider some of the major political events of the post-World War II period. In September 2001 a horrifying terrorist attack virtually shut down the United States for several days. The market was down 4 percent a month later, up 11 percent six months later, and down 9 percent a year later. Five years later it was up 84 percent. In 1990 Iraq invaded Kuwait, precipitating the first Gulf War. Six months later the market was down by 5 percent, but within a year it was up 5 percent. The shocking assassination of President Kennedy in 1963 was followed by a market rally of 15 percent over the next six months and 25 percent a year later. What about the latest political crisis—last year’s battle over the debt ceiling and the downgrade of U.S. debt? A year later the market is up a couple of percent.
A popular belief that the presidential election cycle influences markets says that an election year should be one of the best for investors. Indeed, the S&P 500 Index has risen in 12 of the 16 election years since World War II, but that’s not so unusual: that’s about the same percentage that the market has risen in all years in the same period, says Baltimore-based investment firm T. Rowe Price. Forbes.com noted in March that the stock market fell by 34 percent during the last presidential election year in 2008. “Trying to predict market cycles can lead to oversimplification,” Forbes said. “Market behavior is difficult to predict and sometimes the likelihood of future outcomes are already priced into equity and fixed income markets.”
Former Secretary of the Treasury Lawrence Summers conducted research when he was at Harvard 20 years ago with two other economics professors to test whether big world events had a noticeable impact on stock prices. Their conclusion was that non-economic news has “a surprisingly small effect.” Ned Davis research did another study to see what happens to the market in the intermediate term after a big political or economic crisis. It looked at 28 events prior to 2001. In 19 of the 28 cases, the Dow Jones Industrial Average was up six months after the crisis hit.
These studies reinforce the suggestion that investors should not make changes in their portfolios in reaction to headlines, no matter how major they are. The outcome of those events is unpredictable and in most cases will probably not have a lasting effect on stock prices.
