Avoid trading based on election coverage, experts say: Here's why

Stocks have tended to favor incumbent victories, but experts warn against trading on election news.


In 2020, it seems, the only thing investors can be certain of is that the uncertainty will continue. Stocks have bounced around in recent weeks as market prognosticators have weighed in on potentially market-shaping factors, including the likelihood of a second stimulus package, the prognosis for a viable Covid-19 vaccine, and recent trends in the number of coronavirus cases nationwide.

Among the biggest question marks perplexing investors: the 2020 election. Depending on the result, it could affect everything from the nation's tax policies to its treatment of recreational cannabis use.

For investors looking to get a handle on how stocks might behave following Election Day, market history can be a useful guide. But experts warn against making wholesale changes to your portfolio in anticipation of one election outcome or another. Here's why.

Historically, stock markets have favored incumbents, at least at first

Since 1950, the S&P 500 has returned nearly 10% on average in the year following the reelection of a presidential incumbent, with markets trending upward 71% of the time, according to data from investment firm LPL Financial. The broad stock market has bounced by an average of less than 5% in the year following victory by a challenger, with stocks trending higher only 50% of the time.

The reasons for this are intuitive, says Ryan Detrick, chief market strategist at LPL. "There's some truth to the fact that markets hate uncertainty," he says. "When you have the same person who was just in office, you have a good clue of what their policies are and what they're going to do."

That said, presidents have a greater chance of getting reelected if the economy is humming along. "You're probably not going to win if the economy isn't doing that well," he says. "We've had four elections that have been preceded by recessions, and the incumbent has lost every time."

Recently, incumbents reelected amid strong economies have enjoyed strong market returns following in the first year of their second term, with the S&P 500 returning in the neighborhood of 30% following the reelections of Ronald Reagan, Bill Clinton, and Barack Obama.

Economists expect U.S. GDP to have increased by 30% or more in the third quarter, a sign of a robust bounceback from pandemic-related economic shutdowns, and potentially good news for Trump. Still, the gain would fail to return economic productivity to pre-pandemic levels. Markets also dipped a week out from Election Day as investors fretted about rising coronavirus cases nationwide and worried that the Senate adjourned without passing a new stimulus bill.

You're probably not going to win if the economy isn't doing that well.
Ryan Detrick
Chief market strategist, LPL Financial

Don't let politics interfere with your plan

Historical market data may give investors an idea of how stocks will behave following the election, and analysts have been keen to point out which segments of the market may do well or fare poorly under a hypothetical Trump or Biden win. But making wholesale changes to your portfolio based on these calls is foolish, says Liz Ann Sonders, chief investment strategist at Charles Schwab.

"One of the thing we caution against is buying into the thinking that if X happens, Y is going to happen in the market," she says. "It is never that simple."

Investors should be particularly wary of advice urging them to pile into sectors of the market that analysts expect to benefit from either candidate's policies, such as clean energy for Biden or traditional fossil fuels for Trump, Sonders adds. "In 2016, the two sectors that were seen as beneficiaries of a Trump presidency based on policies and regulations were energy and financials," she says. "Those have been two of the worst performing sectors over the past four years."

One of the thing we caution against is buying into the thinking that if X happens, Y is going to happen in the market. It is never that simple.
Liz Ann Sonders
Chief investment strategist, Charles Schwab

Stocks in these sectors haven't underperformed because of Trump, Sonders adds. "There are just myriad forces at play."

If you're tweaking your portfolio ahead of the election, Sonders recommends focusing on high-quality companies with consistently growing earnings. High-quality firms will show strong free cash flow (cash left over after the company spends to maintain and expand its operations) and a low ratio of debt to equity compared with peer firms.

Such firms have shone amid volatility so far in 2020 and will continue to outrun the more extreme corners of the market — deeply undervalued stocks and fast-growing firms trading at ultra-high earnings multiples, she says.

How 'stillness' can bring financial success

Video by Jason Armesto

For most investors, it makes sense to stick to their investing plan, Detrick says. "The average investor should take a step back and realize the economy is on firm footing," he says. "Whoever wins will inherit an economy that's improving and that will continue to open up as we get vaccines and therapeutics."

The biggest mistake investors can make following the election is letting their politics get in the way of their investments, Detrick says. "If you put your portfolio in cash or gold when Obama was elected, you missed out on eight years of huge stock market gains. If you did the same when Trump was elected, you missed 150 all-time highs."

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