Is History Any Guide?
We find ourselves in the fall of 2020 preparing for a general election with a historically unique set of circumstances: a global pandemic, an economic recession, the fastest equity market correction (and subsequent recovery) on record, multiple natural disasters, and social unrest. And if that wasn’t enough, we face the potential for a contested election outcome, which could add to market volatility through year end. Can history be of any use in such a year?
While no previous election year contains all of these same variables, we can find some insights by examining the individual effect that some of these variables have had in the past election years. The most recent election year with significant social unrest was 1968, which was a loss for the incumbent party. Regarding the economy, the current recession was triggered by the rapid onset of the COVID-19 pandemic in early 2020, forcing a nationwide shutdown that resulted in a severe economic contraction in the first and second quarters (-5% in Q1 and -32% in Q2). The nationwide lockdown and economic contraction led to a 35% drop in the S&P 500, the first 20% of which occurred in just 16 days. Since 1900, the incumbent party has only won re-election three times (out of a total of 11 times) when there was a 20% market decline or a recession in an election year. Since 1952, no incumbent party has won re-election when either of these events occurred. In 2020, both of these events have taken place. However, government stimulus of roughly $4 trillion and support from the Federal Reserve jump-started the market recovery such that by the end of August, the S&P 500 was trading above where it began the year.
Potential Outcomes & Portfolio Implication
Because markets tend to go up over time and reflect many underlying variables, we tend to see little correlation between election outcomes and market returns. Nevertheless, elections do have consequences for markets, particularly in the short-term if they result in an unanticipated outcome or policies that adversely impact business.
Anticipating an election outcome, while never easy, has become increasingly difficult in recent years. In 2016, most polls favored the Democratic candidate, but this was not the election outcome. However, given a 2% margin of error, the polls did accurately predict the Democratic candidate as the winner of the popular vote in 2016. The electoral college outcome produced a different result due to narrow wins in several battleground states. Recent polling numbers indicate a much wider gap between the candidates today, with 8.3% in favor of the Democratic candidate vs. a 2% gap in 2016.
The near-term potential market implications are most pronounced in a unified Democratic scenario (presidency and both houses of Congress). Areas that would likely be most impacted in this scenario are taxes (higher), regulations (higher), healthcare (increased spending), and foreign policy (greater multilateralism). However, the extent and degree to which these policies can ultimately be implemented will depend on the level of consensus within the Democratic party. Any other election outcome will largely result in divided government and a continuation of the status quo.
Facing a year of momentous challenges and uncertainty, investors are well served to remain patient and maintain portfolio diversification. Given the low level of current yields and high equity valuations, maintaining cash at or above target levels provides for future reinvestment opportunities post-election, when election implications will be more apparent. Investors should also revisit their current asset allocation and consider rebalancing, particularly in equity asset classes where the market recovery has resulted in overweight allocations relative to target.
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