What U.S. elections mean for investors
11 March 2020 | Markets and economy
Among Vanguard’s principles for investing success is the idea that investors should maintain perspective and discipline. Such traits can help investors remain committed to their long-term investment programs through periods of market uncertainty.
Few events can be as uncertain and last as long as the run-up to a U.S. presidential election. For a year or more, the election is constantly in the news, frequently in the context of how it may affect investment portfolios. Many observers, including some in the investment management business, offer market predictions based on which candidate or party may be victorious.
Vanguard believes that, as with most-short term predictions, such forecasts are dubious, and that investors should let long-term historical context guide them.
Adam Schickling, an economist in Vanguard Investment Strategy Group, analyzed more than 150 years of asset returns to see whether a relationship with electoral events existed. He examined not only returns under Republican and Democratic presidents but also whether election year uncertainty exposed markets to lower returns and/or higher volatility.
Elections, returns, and volatility
“While historical performance is not a guarantee of future results,” Mr. Schickling said, “150 years is a large enough data set to form reasonable future expectations. Discounting historical results under the guise of ‘this time is different’ is falling prey to a classic investing fallacy.”
Using an allocation of 60% equities and 40% fixed income, Mr. Schickling found a modest return differential under administrations of different parties. “However, this difference is statistically insignificant and time-period-dependent,” Mr. Schickling said. “It offers little to no value in the context of an investment strategy.” He also found that a modest return differential exists between presidential election years and non-election years. “Again,” he said, “this result is statistically insignificant and likely attributable to randomness, or noise.”
Different ruling parties, similar returns
Source: Vanguard calculations of a 60% equity, 40% fixed income portfolio are based on data from Global Financial Data. Years are categorized based on which political party occupied the White House for the majority of the year. Investment involves risks. Past performance is not indicative of future results.
History suggests that investors shouldn’t be concerned about material differences in returns under different political administrations. But how does the market respond during an election year?
Our analysis of monthly returns failed to detect any performance pattern. Several different months were as likely to be ranked first as second, or fifth, or 12th. The number of unique months in any performance rank over the last dozen presidential election years averaged 7.2. For comparison, a completely random data set would average 7.8 unique months in each performance rank, Mr. Schickling said. In short, monthly returns during election years are very close to random.
“Most tactical election-year investment strategies have suffered from look-ahead bias, generating hypothetical outperformance using information that wasn’t available at the time,” Mr. Schickling said. “A ‘buy November’ strategy may have been promoted heading into 1984, based on its performance in 1972 and 1980, but then it underperformed in 1984 and 1988.”
A near-random monthly performance distribution
Source: Vanguard calculations of Standard & Poor’s 500 Index returns in election years, based on data from Thomson Reuters. Investment involves risks. Past performance is not indicative of future results.
Investors similarly shouldn’t expect equity market volatility to be higher in the run-up to an election. Mr. Schickling found that equity volatility has been modestly lower in the weeks leading up to and following a presidential election than over a full market period. The result is not statistically significant.
Equity volatility is lower in the weeks before and after an election
Source: Vanguard calculations of S&P 500 Index daily return volatility from January 1, 1964, through December 31, 2019, based on data from Thomson Reuters.
A multiple-issue issue
So what might be different about a U.S. presidential election—or any election—in an investor’s psyche? Most events that might lead an investor to think about straying from a well-considered long-term strategy are single-issue events, said Jonathan Lemco, Ph.D., a senior investment strategist in Vanguard Investment Strategy Group. “U.S. presidential election-year politics touch upon multiple issues to inform four years of policy-making,” he noted.
“It’s important that investors not lose sight of their own goals and their own long-term strategies,” Mr. Lemco said. “Financial markets are incredibly complex systems affected by 101 different external variables whose levels of importance depend on valuations, business cycles, and investor sentiment, just to name a few. Politics is just one of these many variables, offering little to no insight in isolation.”
IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of September 30, 2019. Results from the model may vary with each use and over time.
1. Source: Vanguard calculations, based on the performance of the MSCI World Index from January 1, 1980, through December 31, 1987, and the MSCI AC World Index thereafter. Both indexes are denominated in U.S. dollars. Our count of corrections excludes those that turned into bear markets. We count corrections that occur after a bear market has recovered from its trough, even if stock prices haven’t yet reached their previous peak.
2. These potential outcomes for long-term investment returns are generated by the Vanguard Capital Markets Model® (VCMM) and reflect the collective perspective of our Investment Strategy Group. Return projections exclude the effects of investment costs, taxes, and inflation. The expected risk premiums—and the uncertainty surrounding those expectations—are among a number of qualitative and quantitative inputs used in Vanguard’s investment methodology and portfolio construction process.
The contents of this document and any attachments/links contained in this document are for general information only and are not advice. The information does not take into account your specific investment objectives, financial situation and individual needs and is not designed as a substitute for professional advice. You should seek independent professional advice regarding the suitability of an investment product, taking into account your specific investment objectives, financial situation and individual needs before making an investment.
The contents of this document and any attachments/links contained in this document have been prepared in good faith. Please note that the information may have become outdated since its publication, and any information sourced from third parties is not necessarily endorsed by The Vanguard Group, Inc., and all of its subsidiaries and affiliates (collectively, the “Vanguard Entities”).
This document contains links to materials which may have been prepared in the United States and which may have been commissioned by the Vanguard Entities. They are for your information and reference only and they may not represent our views. The materials may include incidental references to products issued by the Vanguard Entities.
The information contained in this document does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The Vanguard Entities may be unable to facilitate investment for you in any products which may be offered by the Vanguard Group, Inc.
No part of this document or any attachments/links contained in this document may be reproduced in any form, or referred to in any other publication, without express written consent from the Vanguard Entities. Any attachments and any information in the links contained in this document may not be detached from this document and/or be separately made available for distribution.
This document is being made available in Hong Kong by Vanguard Investments Hong Kong Limited (CE No. : AYT820) (“Vanguard Hong Kong”). Vanguard Hong Kong is licensed with the Securities and Futures Commission (“SFC”). The contents of this document have not been reviewed by the Securities and Futures Commission in Hong Kong. Investment involves risk. Past performance is not indicative of future results. Investors are advised to consider their own investment objectives and circumstances. If you are in any doubt, you should seek professional advice.
Copyright, trademark and other forms of proprietary rights protect the contents of this document. You may not copy, publish and/or distribute any derivative works from the information from this document.