In less than a month, Democrats and Republicans will convene their quadrennial national conventions (Democrats, August 17- 20 and Republicans, August 24-27) to formalize their presidential and vice-presidential nominees. In 68 days after the Republican convention, the U.S. electorate will reaffirm the administration of the 45th president or begin preparation for the January 20, 2021, inaugural of the 46th president. The battle for residency at 1600 Pennsylvania Avenue will command the most attention, but the post-election composition of the House of Representatives and Senate could be equally consequential.
Investors typically try to handicap what effect a potential winner’s policies might have on the stock market. Historically, however, what the stock market does through the three months immediately before the election often foretells who gains the White House.
Consider elections from 1944 through 2016: When the S&P 500 has a gain from July 31 through October 31, the incumbent or his political party has retained the White House nearly 82% of the time. In all but one year, whenever the S&P 500 declined in price during these three months, the incumbent or his party's candidate lost the election. The sole exception occurred in 1956 when President Dwight D. Eisenhower won re-election despite the S&P 500 falling 7.7% during the critical three-month period. Considering all possible indications of election outcomes based on market performance, the July 31-October 31 predicator has been correct 84% of the time.
It might seem to be reasonable that if a candidate garners a large majority of votes, the election tailwind might provide the equity market with a boost. Looking at the seven largest Electoral College vote majorities suggests otherwise—in four of the seven instances, the S&P 500 ended the post-election year with a loss.
CONGRESSIONAL CONTESTS ALSO CRITICAL
The composition of the legislative branches can be as important as who occupies the White House. The winning presidential candidate ideally would like to have a strong supporting cast in the House and Senate to aid in getting priority programs enacted. As the table on the left shows, the odds of a positive market are better when there is a unified government, which makes the Congressional contests this year potentially critical as they could determine the President’s ability to enact preferred programs.
The narrow Republican majority in the Senate has given rise to concern that a Democratic election sweep could give lead to policies the market might not like. History, however, suggests that an adverse market reaction is far from assured. A Democratic president was joined by a Democratic majority in both houses of Congress in 1948, 1960, 1976, 1992, and 2008. The S&P 500 fell in three of these five instances for an average 2.4% loss in November following the election. This was followed by December gains averaging 3.1%, and through the five subsequent calendar years, the S&P 500 produced an average 10.4% gain with only one year showing a loss.
As detailed in the table below, data assembled by CFRA-Standard & Poor’s suggest that the political makeup of the legislative and executive branches of government influences sector results.
GAINS IN ELECTION-YEAR 4Q
Regardless of the election result, the stock market usually posts a gain in the fourth quarter of election years. The S&P 500 had a fourth-quarter loss in only three of the past 20 elections.
President George W. Bush and President Barack Obama had the distinction of winning elections in four instances of notable fourth quarter market results.
Bush won the 2000 election amidst substantial controversy, as on election night, the electoral votes of the state of Florida were undecided. Returns showed that Bush had won Florida by such a close margin that state law required a recount. A month-long series of legal battles led to the highly controversial 5-4 Supreme Court decision Bush v. Gore, which ended the recount. Bush won Florida by 537 votes, a margin of 0.009%. Perhaps the controversy contributed to the fourth-quarter 8.091% loss in the S&P 500, which was the second-worst election year fourth-quarter loss. Four years later, Bush was re-elected as the S&P 500 posted its best fourth-quarter election year result since 1950 with an 8.733% gain.
With the Great Recession unfolding, Obama’s 2008 win came with the S&P 500 posting its worst loss (-22.558%) in an election year fourth quarter. His re-election year also saw the S&P slipping in the fourth quarter, but only by 1.005%. In all four of these instances, the first quarter of the year after the election, the market reversed the direction it had in the election year final quarter. This was most dramatic when after falling 22.558% in the fourth quarter of 2008, the S&P rose 11.997% in the first quarter of Obama’s second term.
READING INTO THE POLLS
Polling has become an integral part of election campaigns, as candidates attempt to gauge how they stand relative to their opponent. Poll results often lead to changes in campaign strategy.
Polling accuracy always has been questioned, but never more so than in the 2016 presidential campaign. Hillary Clinton came to Election Day with polls suggesting that her chance of winning was as high as 99% with national polling showing her leading Trump by more than seven percentage points in mid-October 2016. In the end, President Trump won the Electoral College count by a 56.50% to 42.20% margin. Excuses for the major miss permeated post-election press coverage.
In what may be a sad commentary about polling science, a study showed that the polls of the 2016 presidential election were about as accurate as polls of presidential elections have been on average since 1972. Polls of gubernatorial and Congressional elections in 2016 were about as accurate, on average, as polls of those races since 1998. Polls of elections since 2016, including the 2017 gubernatorial elections and the various special elections to Congress this year and last year, were only more accurate than average. Polling apparently is no better outside of the U.S. as the debate over Brexit in the United Kingdom showed. If, as one study demonstrated, the average error in all polls conducted in the late stage of campaigns since 1998 is about six percentage points, the range to arrive at this percentage still could be and often is quite wide
Monitoring statewide polls, however, could be important as six states account for nearly 71% of the Electoral College votes needed to claim the White House.
Political intrigue catches the attention of many voters, but the economy typically is the key driver around election sentiment. There have not been many quarters when GDP growth has been extremely poor. In 1960, weak GDP growth led to the Republicans ceding the White House to the Democratic candidate President John Kennedy, and one of the worst pre-election quarter GDP results helped Democrat Barack Obama take the White House following two terms for Republican George W. Bush. In 2000, Republicans regained the White House after President William Clinton’s two terms, but GDP growth the quarter before the 2000 election was one of the weaker periods during Clinton’s tenure. President Trump, likewise, grabbed White House residency as the Obama administration wrestled with the lingering negative effects of the Great Recession. These examples suggest that the 2021 resident at 1600 Pennsylvania Avenue might be determined by this year’s third-quarter GDP.
PARTY MIX IN HOUSE AND SENATE
In the November 2018 midterm elections, the Democratic Party won a majority in the House of Representatives, while the Republican Party increased its majority in the Senate. This is the first split Congress since the 113th Congress of 2013-2015, and the first Republican Senate/Democratic House split since the 99th Congress of 1985-1987. The Congress has the youngest class by mean age in the past three election cycles.
Presently, the Senate consists of 53 Republicans, 45 Democrats and two Independents who according to Senate documents typically side with the Democrats. There are 35 seats up for election this year, including special elections in Arizona and Georgia. Of these, Republicans hold 23 seats. Winning senatorial candidates tend to be affiliated with the same party as the winning presidential candidate. Conventional wisdom suggests that the odds are high that regardless of who wins the presidency there will be a split federal government, but the number of Senate seats up for grabs leaves open the chance for a major political power shift.
Several major policy differences between the two candidates are likely to generate election influence. Biden and Trump have widely different views on energy policy. Biden clearly wants to diminish and eventually prohibit the use of fossil fuels while Trump endorses the expanded domestic production of oil and natural gas including on public lands. Taxes are another key difference as Biden would raise top tax rate on those making over $400,000 to 39.6%, raise capital gains and the qualified dividends tax rate for those earning more than $1 million, and among numerous other changes, phase out qualified business income deduction for those making over $400,000. Trump generally wants to maintain the current tax structure.
Clearly, progress on virus mitigation along with economic data could shape voters’ attitudes through the next few months, but it seems relatively easy to predict a winner in at least one aspect of this year’s presidential race.
Early estimates suggest political advertising could approach 60% more than the record expended in the 2016 election, which should put a smile on the faces of television network officials as well as officials at local media outlets.
July 14, 2020
GREGORY M. DRAHUSCHAK
Equity Market Strategist
