3 takeaways on U.S. presidential elections and stock markets

 Hiker admiring Mount Rushmore

Mona Mahajan, Senior Investment Strategist

Although the U.S. presidential election is still a couple of months away, the headlines and news flow have been constant and, in some cases, downright jarring. As investors, you may be wondering, “What impact will this election have on the markets and my portfolio?”

First and foremost, it’s important to keep emotion out of your investment decisions. Using history as a guide, a few interesting trends emerge around U.S. presidential elections that may provide some perspective and help alleviate concerns — regardless of who takes office in November. 

Let’s explore three key trends on what history tells us about U.S. presidential elections and stock markets:

1. Year 4 of an election cycle tends to be good for markets

Looking back at the four-year election cycle since 1928, the following chart shows that year 3 tends to be the best-performing year for the stock market. We saw a healthy market return last year, with the S&P 500 up about 24%. And year 4 of the election cycle — which is this year — tends to be the second-best year for market gains.

There are two theories around why this may occur: One is that some of the uncertainty is lifted once election day is behind us. The other is that perhaps administrations try to create favorable conditions ahead of election day.

Overall, the stock market returns about 12% on average during a presidential election year, independent of who wins. And this year, the S&P 500 is already up about 18% as of mid-July, on pace for solid returns even if we see bouts of volatility in the months ahead.

 Chart showing presidential cycle returns
Source: Morningstar Direct, Slickcharts, Edward Jones. S&P 500 Total Return Index. Past performance is not a guarantee of future results.

2. Stock markets focus on fundamentals

Presidential policy leanings don’t tend to sway markets as much as fundamentals. In the weeks ahead, we will certainly hear more about each candidate’s policy agendas around key areas such as taxes, tariffs and energy. But history shows it may not be wise to make portfolio decisions based on presidential policy choices.

For example, after the 2016 election of President Trump, investors may have been inclined to overweight the traditional energy sector. Similarly, after the 2020 election of President Biden, many may have favored clean energy stocks. However, these moves would have yielded poor returns.

During the Trump presidency, clean energy outperformed traditional energy by 43% per year. During the Biden presidency, traditional energy has outperformed clean energy by 53% per year. Rather than political policy, markets were focused on the growth and earnings fundamentals of these sectors, which tend to be bigger performance drivers.

 Chart showing Macro forces are a more powerful driver" - this is the one that's missing
Source: Morningstar Direct, Edward Jones. Past performance is not a guarantee of future results.

3. Volatility may rise around election day but could be 
short-lived

While fundamental conditions predominantly determine market performance, elections can influence short-term volatility. Anxiety and uncertainty tend to increase as November approaches.

This may explain why market volatility (as tracked by the CBOE Volatility Index, or VIX, often referred to as the Wall Street “fear gauge”) has tended to rise notably two months prior to election day. However, by 30 days after the vote, volatility tends to subside, returning to normal levels around 60 days postelection.

 Chart showing volatility index
Source: Bloomberg, Edward Jones. Past performance is not a guarantee of future results.

With this year’s election, we expect Congress to remain fairly divided, and policy gridlock will likely continue. This implies that regardless of who wins the presidency, it will be difficult to pass any major new legislation or reform, and the system of checks and balances remains intact. Markets may welcome this, as political gridlock also means a more transparent operating environment for companies, with less policy upheaval.

The bottom line

Overall, markets have had a solid start so far this year, driven largely by strong corporate earnings growth, the potential for Federal Reserve interest rate cuts, and growing enthusiasm around artificial intelligence (AI). While the polls may continue to shift, and this year’s presidential election will likely continue to generate headlines, keep in mind that enacting real policy change takes time. The election and policy agendas may influence short-term market fluctuations, but history shows us that they are not the primary drivers of long-term investment returns.

Instead, work with your financial advisor to potentially take advantage of any election volatility. It could present an opportunity to diversify or rebalance your portfolio, or add quality investments at better prices, to help you meet your long-term financial goals, no matter who is in the White House.