Lexicon Financial Group Weekly Update — October 2, 2024
“This election is about who’s going to be the next President of the United States!”
From the desk of Craig Swistun, CIM, MFA-P, Portfolio Manager, Raymond James Investment Counsel, and Wayne Hendry, Client Relationship Manager, Raymond James Investment Counsel
Looking Around
With elections in the United States just over a month away, the world watches. The U.S. economy is still the largest in the world, so these are important decisions. Will the U.S. retreat into protectionism and tariffs? We don’t have a crystal ball of course, but this is worth watching. As the saying goes, when the U.S. sneezes, the world catches a cold.
General elections can and do impact equity markets. Markets hate uncertainty. Once the ballots have been cast, markets continue to adjust to the new political reality as they begin to anticipate the promised policies of the candidates will become reality. A clear margin of victory and a returning incumbent tend to reduce uncertainty and minimise market volatility.
Successfully predicting election outcomes is not dissimilar from predicting which direction financial markets will take in the future. Just as analysts have predicted nine of the last five recessions, they are terrible at predicting election results. A good example here is the 2016 U.S. presidential election, when estimates put the likelihood of Hilary Clinton winning at between 71 and 99 per cent. And we all know how off the mark those estimates were.
Financial markets reflect this correct prediction challenge. In the absence of a clear consensus about the outcome, we see larger daily price changes that tend to offset each other. While these leave prices unchanged overall, they create amplified market fluctuations over the election period that cause concern. The size of the fluctuations depends, in part, on the electoral system. Majority systems – such as Canada and the United Kingdom’s ‘first-past-the-post’ and the electoral college in the United States – where losing by 0.5 per cent has the same outcome as losing by 95 per cent, are less predictable than proportional representation systems and can affect stock market returns significantly.
One study finds that, within the 51 days surrounding elections, stock market returns exhibit more than 20 per cent higher volatility than anticipated. What’s more, the compensation for bearing this risk appears to be relatively modest.
The link between elections and the economy is not new. In fact, research from the 1970s pointed out that politicians often boost the economy before elections, to gain favour, only to follow up with tougher measures thereafter. There is also some evidence to suggest that it is not just the timing of elections that affect stock markets but the outcomes too. Contrary to the general assumption that Wall Street prefers Republican presidencies, evidence suggests that stock markets historically perform better during Democratic presidencies. Other research highlights that the reaction of any particular share to election outcomes will depend on the tax policies that may affect the company or the market sector it is part of. (1)
Historically, presidential elections usually add an extra element of uncertainty to investing. On top of assessing the path of the Fed, the stability of profits and the consumer, and navigating economic resilience vs. recession, investors will have to grapple with the barrage of information about the upcoming elections. Uncertainty can create investment opportunities, investors often make their worst mistakes during uncertain times, which can sometimes take years for portfolios to recover from. As we have stated numerous times before, sticking to an investment plan with a disciplined approach to investing is critical to achieving long-term investment goals. Here are some things that you can do to achieve this:
Don’t let how you feel about politics overrule how you think about investing - A survey from the Pew Research Centre, which asked Americans how they feel about economic conditions, revealed that Republicans often feel better about the economy under a Republican president, while similarly Democrats often feel better about the economy under a Democratic president. Investors often make portfolio decisions based on their economic outlook. Investors who allowed their political opinions to overrule their investing discipline may miss out on better returns during political administrations they didn’t like.
Markets, as we all know, hate uncertainty and the end of elections almost always reduce it - During election years, returns generally tend to be lower and volatility tends to be higher because markets do not like the uncertainty that elections breed. Since 1932, S&P 500 returns on average were 6.2 per cent during election years vs. 9.6 per cent during non-election years. Realized volatility was 16.5 per cent during election years and 15.3 per cent during non-election years. The average market drawdown in a given calendar year since 1980 was 14.2 per cent but 16.3 per cent in election years vs. 13.5 per cent in non-election years.
Election-driven volatility tends to subside quickly after election day
Source: Bloomberg, CBOE Volatility Index
These averages however don’t tell the full story, as recent presidential election years have been particularly volatile when there are historic market drawdowns. For example, the 2000 sell-off was related to the bursting of the tech bubble, 2008 saw the onset of the financial crisis, and 2020, as we all know, was the year of the pandemic. That said, after election day, uncertainty fades and, regardless of the result, markets move on - median returns in the first three quarters of an election year were 1.9 per cent compared to 3.1 per cent in the fourth quarter, going back to 1936.
Market timing can be a dangerous strategy around elections - The presidential elections in 2016 and 2020 are prime examples of this. In the early hours of November 9, 2016, futures plummeted as election results were coming in, but markets closed 1.1 per cent higher after that day’s regular trading session when the results were finalized. Markets also rallied strongly after the 2020 election. In both cases, there was a pre-election rally of three per cent between the prior Friday and election day itself, as markets turned before many ballots were even cast. Some investors may be happy to sit on the sidelines until election uncertainty passes, but risk missing subsequent rebounds, which typically occur faster than investors can get back into the market. (2)
As always, we are here to talk to you about your investments with us and are ready to provide a second opinion to anyone you know on the markets and/or their investment strategy.
Read and Watch
Want deeper insight into topics in your Weekly Update? Then, read and/or right click:
Educating for Europe’s Unique Style of Economic Growth
Economist urges China to sober up after stock rally as boom-bust risk rises
Raymond James Markets & Investing: The great American road trip – CIO Larry Adam, October 1, 2024
Looking Back
Last Friday, the blue-chip Dow Jones Industrial Average closed at a record high, thanks to a subdued U.S. inflation report that heartened investors and lifted small-cap stocks which stand to benefit from more interest rates cuts by the U.S. Federal Reserve (Fed). The TSX, Nasdaq and the S&P 500 all moved slightly lower last Friday. However, all of these markets logged their third consecutive week of gains. (3)
U.S. markets reacted positively to new stimulus measures in China. Chemicals and materials stocks were particularly strong on hopes for a rebound in Chinese demand. Copper prices also increased, raising hopes that “Doctor Copper” was again reflecting a healthier global industrial economy. Technology stocks outperformed, thanks to reports of a possible takeover of Intel and news that NVIDIA’s CEO had ceased sales of his own shares in the company. On top of this, chipmaker Micron Technology surged and seemed to provide a general tailwind for the sector, following its upbeat outlook for artificial intelligence (AI) demand.
Before trading opened last Friday, the Commerce Department reported that the Federal Reserve’s preferred inflation gauge, the core (less food and energy) personal consumer expenditures (PCE) price index, rose only 0.1 per cent in August, a tick below expectations. On a year-over-year basis, the index climbed only 2.2 per cent, close to the Fed’s 2.0 per cent long-term inflation target and the least since February 2021. Personal incomes and spending were down in August, suggesting a further moderation in inflationary pressures.
European markets rebounded, as evidence of slowing business activity spurred hopes for more interest rate cuts. China’s package of measures to stimulate its economy also helped lift investor sentiment.
Japan’s stock markets gained over last week with the latest commentary from the Bank of Japan (BoJ) that was more dovish weighed on the yen to provide a favourable backdrop. Optimism also came from China’s stimulus announcements. Given the share of Japanese exports that go to China and Japan’s sensitivity to Chinese purchasing managers’ index and other economic data, these announcements boosted the many Japanese companies that are direct or indirect China beneficiaries.
Chinese markets surged after Beijing unveiled a slew of measures to shore up the economy. This rally marked the biggest weekly gain for the benchmark CSI 300 since 2008, when Beijing unveiled a massive stimulus package during the global financial crisis. This stimulus package is a positive development for China’s economy and will bolster near-term activity, but it may not be large enough to sustainably free China from its weaker growth trajectory. (4)
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable, but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors, and we recommend that clients seek independent advice from a professional advisor on tax-related matters.
How do elections affect the stock market?, Clive Walker, Economics Observatory, June 26, 2024,
Investing in an election year, Meera Pandit, J.P. Morgan Asset Management, January 23, 2024
The close: Dow closes at record high on tame inflation report, but TSX slips, Globe and Mail, September 27, 2024
Global Markets Weekly Update, T. Rowe Price, September 27, 2024
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Looking to Learn?
If you want to know more about some of the topics we wrote about this week, just click on the links below:
What Will the Stock Market Do as Election Nears?
Will the 2024 presidential election affect the stock market?