US elections – An important event for financial markets

This elevated pre-election volatility also tends to coincide with lower returns in the pre-election period compared to post-election returns. In contrast, the post-election phase often brings a sense of relief and renewed investor confidence, particularly in U.S. large-cap stocks, which typically experience a noticeable uptick. Historical data from the past 11 election cycles, starting in 1980, reveals an interesting trend in Russell 1000’s performance. On average, the three months leading up to an election yield returns of approximately 1.2% (4.76% annualized) as illustrated in Exhibit 3. However, the three months following an election see nearly double that growth, with returns averaging 2.3% (9.15% annualized). Intriguingly, only three of the eleven elections experienced negative returns in the post-election period (Exhibit 2). Notably, these exceptions occurred during times of significant economic distress, such as the Dot-Com Recession in 2000 and the Great Recession in 2008.

The first year of a new presidency has often been a period of stronger-than-usual returns, standing out within the broader four-year presidential cycle (Exhibit 3). This trend is primarily driven by a reduction in political uncertainty following the election, combined with market optimism about potential new policies and their economic impact. Investors, with their forward-looking perspective, tend to react positively to the prospect of fresh fiscal measures, be it in the areas of tax reform, infrastructure investments, or financial deregulation. These policies are generally seen as growth drivers, boosting market confidence. As the dust settles on election-related volatility markets have typically entered a more stable phase and favoured US equities. It is worth noting, the initial year of a presidency is not without its challenges, as the transition from campaign rhetoric to actual policymaking can introduce risks. 

Financial markets and macroeconomic indicators, on average, have exhibited noticeable differences depending on which political party holds presidential power. However, it is important to note that market returns are also heavily influenced by other factors such as monetary policies and the structure of industries, which operate independently of presidential elections.

Since 1981, U.S. large-cap stocks have generally outperformed small-caps (Exhibit 4). This outperformance may be attributed to the inherent characteristics of large-cap companies, such as their diverse revenue streams, stronger balance sheets, and greater access to global markets, which are becoming more important with the gradual consolidation in most industries witnessed over recent decades. These factors allow large-cap firms to consistently perform well, regardless of the political environment. While both large- and small-cap equities have seen positive returns during different presidential terms, the outperformance of large-cap equities over small caps has been more pronounced during Democratic administrations.

On the macroeconomic front, it is often debated whether Democratic or Republican administrations have overseen stronger GDP growth. Earlier research, such as the study by Blinder and Watson^[1] calculated that since World War II to 2013, US real GDP growth averaged 4.3% under Democratic presidential leadership compared to 2.5% under Republicans. However, our analysis of data since 1980 (Exhibit 5) shows that while Democratic administrations have still seen slightly higher growth since 1980, the gap was narrower, with real GDP growth being about 35 basis points higher, on average, under a Democratic administration. Moreover, the nominal GDP growth under Republican administrations has been higher reflecting their policy preferences that have been more inflationary. 

In addition, financial conditions have varied across administrations (Exhibit 6). The Chicago Fed Financial Conditions index has indicated that financial conditions have on average, been looser under Democratic administrations compared to Republican ones. Looser conditions often reflect a more accommodative environment for borrowing and investment. However, when it comes to market volatility, the RVX index, which measures implied volatility in the equity market, has generally been higher during Democratic administrations than during Republican ones. This suggests that while financial conditions may have been more supportive under Democratic administrations, market participants have still priced in higher uncertainty during these periods.

In conclusion, US elections have a profound impact on both domestic and global markets, shaping the direction of investor sentiment and policy expectations. Typically, this has been reflected in higher (implied) market volatility in the months leading up to the election and a drop in volatility immediately post-election. In keeping with this trend of uncertainty and volatility around US presidential elections, the 3-month post-election return has, on average, been higher than the 3-month pre-election return. The first year of a new presidency is typically marked by a boost in returns as political uncertainty eases and markets anticipate new economic policies, and this first year of the four-year presidential term, on average, has been the best for US equity markets within a four-year presidential term. These are impacts from the increased uncertainty around elections on market volatility and returns, irrespective of the election outcome.

We have also observed differences in index performance and GDP growth, during Democratic and Republican administrations, which are ultimately influenced by a range of economic and market factors. Policy differences between Democratic and Republican administrations—ranging from trade policies to foreign relations—highlight the varying market conditions that investors must navigate. Monetary policies and global events, independent of US presidential elections, often play a larger role in shaping market outcomes than the presidency itself, underscoring the complex interplay between politics and economic performance.

However, what the data shows is that, on average, returns were positive post-elections under either type of administration, indicating the potential benefits to investors of staying invested through the associated volatile market period. As we look to future elections, investors should remain mindful of these historical trends, while also considering the current macroeconomic and geopolitical landscape.

(1) Blinder, Alan S., and Mark W. Watson. "Presidents and the US economy: An econometric exploration." American Economic Review 106.4 (2016): 1015-1045.