What drives the stock market? Quite often, it is fundamental factors such as the strength of the economy and its impact on corporate profits. At other times it is affected, at least in the short term, by external factors that can upend investor expectations and drive markets in a positive or negative direction.
One of the most obvious external factors that might come into play for markets this year is the upcoming presidential election. This is the kind of election year that has some built-in market uncertainty. It marks the end of the second term for President Barack Obama, which means that a new occupant will sit in the Oval Office in January 2017. Regardless of who wins, the leadership transition will likely result in some policy changes in the near future.
Dealing with uncertainty
This election season has been marked by unusual twists. In the Democratic Party, Hillary Clinton, a longtime party stalwart faced a surprisingly difficult challenge before earning the nomination for the chance to become the country’s first woman president. On the Republican side, Donald Trump, a celebrity newcomer to the party captured the nomination, overcoming a number of more experienced politicians.
Even without these twists, it isn’t uncommon for the stock market to exhibit a degree of volatility in the run-up to an election, at least until the likely outcome is clearer. One of the key issues that could affect markets is the possibility that control of the White House could change to a different party. According to an analysis by the Ameriprise Investment Research Group, the potential for such a change tends to increase stock market volatility. This can be particularly true in the final weeks leading up to the election. Investors should be prepared for circumstances where the “noise” generated by the campaign contributes to market fluctuations.
Is history a guide?
Other data may provide clues as to what to expect in the markets. According to Standard & Poor’s, since 1900, U.S. stocks have declined by an average of 1.2 percent in the eighth year of a presidential term. There are two points of caution with this statistic:
1. There are a limited number of times when this circumstance has occurred.
2. The last time it happened, in 2008, we were in the midst of the Great Recession. The markets were down 41 percent that year, which dramatically changed the average return for this specific measurement.
What may be a more important consideration for investors than who is the new president is whether we enter the election and post-election season with a great deal of uncertainty about policy direction.
The impact on specific market sectors
Although it’s speculative to try and predict the outcome of the election and all of the policy implications each party would impose, the result of the election is likely to influence key industries. Among the sectors of the market that could be affected in different ways are:
• Healthcare – what is the future of the Affordable Care Act and the general direction of health insurance coverage in the U.S.?
• Energy – will production of fossil fuels continue to be encouraged or will greater emphasis be put on alternative energy sources?
• Security – how will the defense budget be affected given the increased focus on global security?
It’s about more than the president
It’s true that our president has tremendous influence in the direction our country takes. However, it’s important to remember that there are many others who play a role in making policy that can affect the investment environment. These include members of Congress (many who are also up for election this year), local and state legislators, Federal regulators and other officials. For example, the Federal Reserve controls monetary policy, which includes monitoring inflation and the Federal interest rates. Politicians have limited to no influence over policy decisions made by the Fed.
Also keep in mind that the presidential election doesn’t have the same impact over U.S. markets as it once did. External events, many of which are overseas, increasingly affect the markets, and are often out of the control of elected officials. These events include natural disasters, terrorist attacks, financial crises and the financial results of publicly held companies.
What this means for your finances
While it’s natural to think about the impact of the election on your investments, it’s only one factor. Stay attuned to the bigger picture of your long-term goals. Review your portfolio diversification and risk tolerance with a financial advisor for an objective perspective on your financial situation.