US Elections vs. the Stock Market | Summary and Q&A

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October 10, 2020
by
Ben Felix
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US Elections vs. the Stock Market

TL;DR

US presidential elections have historically had minimal impact on short-term stock market returns, but stock market volatility may increase during tight elections. Long-term stock market returns have shown a positive correlation with Democratic leadership, which can be attributed to higher risk aversion rather than the political party itself.

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Key Insights

  • 🍉 Short-term stock market returns are not greatly impacted by election results.
  • 👨‍💼 Stock market volatility may increase during tight elections due to economic policy uncertainty and the business cycle.
  • ✋ Long-term stock market returns have shown higher average returns under Democratic leadership, but this is likely due to higher risk aversion leading up to elections.
  • 🥳 The correlation between stock market returns and political party leadership is not causational, but rather a reflection of economic conditions that lead to higher risk aversion and Democratic leadership being voted in.
  • 🍗 Staying invested in the market to capture risk premiums is more important than trying to time the market based on election outcomes.
  • ⌛ The equity risk premium has been persistent over time for those who have stayed invested.

Transcript

  • With the upcoming United States presidential election, lots of investors are worried about how the election outcome might affect their investments. This is not a new word. Elections are stressful times, and it seems obvious that the outcome should impact the stock market. Rhetoric from across the political spectrum certainly doesn't help. Fortuna... Read More

Questions & Answers

Q: How do election results typically impact short-term stock market returns?

Short-term stock market returns are not significantly affected by election outcomes, with the 12 months following an election delivering slightly lower returns on average compared to other 12-month periods.

Q: Do stock market volatility levels change during elections?

Stock market volatility may increase around tight presidential elections, as evidenced by spikes in the US economic policy uncertainty index during elections like 2000, 2004, and 2016. Economic policy uncertainty and the business cycle play a role in heightened volatility.

Q: Is there a difference in long-term stock market returns based on political party leadership?

Long-term stock market returns have shown higher average returns under Democratic leadership compared to Republicans. However, this correlation is more likely attributed to higher risk aversion and the timing of elections rather than the political party itself.

Q: What is the explanation for the higher stock market returns under Democratic leadership?

The higher stock market returns under Democratic leadership can be explained by a model of political cycles driven by time varying risk aversion. Risk aversion tends to be higher under Democrats, leading to a higher equity risk premium and thus higher average returns.

Summary & Key Takeaways

  • Short-term stock market returns are not significantly affected by election outcomes, with the 12 months following an election delivering slightly lower returns on average compared to other 12-month periods.

  • Stock market volatility may increase around tight presidential elections due to economic policy uncertainty and the business cycle.

  • Long-term stock market returns have shown higher average returns under Democratic leadership, but this correlation is more likely due to higher risk aversion and the timing of elections.

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