We’re only 18 months away from another presidential election, and this one could be the most contentious in a generation. With so much on the line, let’s assess the market impact of a presidential election.
Charlie Munger once said, “Politics is the art of marshaling hatreds”1. Politics ignite powerful emotions, and since emotions dominate the short-term direction of asset prices, politics can have a profound effect on the stock market over a few days, weeks, or months.
This was the case after Barack Obama won his re-election in 2012. The very next day, the market began a steep decline that sent the index down over 5.5% in a single week2.
The market reaction seemed justified to those who disagreed with his politics. This cohort prophesized that Obama’s policies towards big business and his party’s scheme to fix healthcare would bankrupt America. Hence, a drop in an index that depends on the future health of the American economy made a lot of sense.
However, the S&P 500 recovered within a month. It was as if all the harm that Obama could do magically disappeared. The market rose over 50% through 2015, and more than tripled during his presidency2.
The same goes for Republicans. In 2002, President Bush enacted many controversial policy decisions, including cutting taxes and expanding the deficit. He fought an unpopular war and was vilified for acting as the world’s police at the expense of taxpayers. However, the S&P 500 did not seem to notice for too long. The market almost doubled through the end of 20072.
Two parties with opposing views, yet both times the stock market surged. How can that be? Were the Republicans wrong to think Obama was bad for business? Did the Democrats make false assumptions about the impact of Bush’s foreign policy on the domestic economy?
The answer to these questions is that while the President may be the most powerful person in the world, nobody is strong enough to direct the entire economy. An administration can certainly promote or kill sectors within it, but the overall beast is just too big and complex.
Consider where nearly all of the world’s innovation and entrepreneurship is born. Self-driving cars that run on batteries, breakthroughs in cancer treatments, taxis on demand, artificial intelligence, cell phones that act as credit cards, virtual reality, fracking, and so many other world-changing ideas were conceived and commercialized here under both Democrat and Republican leadership.
Simply put, presidential policies can be good or bad for stocks, but there are thousands of drivers of stocks. It’s a stretch to assume that one input, like a new President, can suppress the collective power of the tailwinds already in place.
Politics vs. policy
It’s also important to differentiate between politics and policy. By analyzing the characteristics of the two, we can better
understand how each can impact financial markets and the broader economy. Five, in particular, are worth noting:
- Substance: Politics allow a candidate to make claims that have no basis or support of any kind. Policy is an actual plan comprised of several moving parts vetted through committees to ensure thoroughness.
- Commitment: Politics allow a candidate to make promises they don’t intend to keep. Policy requires enforcing what is passed into law, which often restricts the ability to roll back legislation once implemented.
- Speed: Politics move at warp speed because promises are just words. Policy moves at a snail’s pace due to endless amounts of red tape and the checks and balances of the government.
- Accountability: Politicians will say anything on the campaign trail with little fear of expectation to deliver. Those who create policy are held accountable for their actions and are expected to deliver.
- Flexibility: A politician can promise one thing to an audience today and the exact opposite to a different audience tomorrow. Once policy is executed, making changes can often be more difficult than the initial implementation.
Add it all up, and politics aims to win votes (short-term), whereas policy governs and enacts change (long-term). These contrasting features of politics and policy make their impact on the economy and financial markets noticeably different.
That’s why we tend to see big reactions in the stock market after an election. Politics (emotions) fuel markets briefly. However, emotions usually don’t last long enough to alter our $24 trillion economy.
Policy is what matters because it is the process that converts talk into action. But this process is also designed to kill most ideas and only implement those that have passed a series of reviews from key stakeholders. Even after policy is passed, the effects can often take years to be felt.
The complexity of passing policy in this country makes it very difficult for any administration to enact too much change too quickly. Therefore, a candidate may conjure up some powerful emotions on the campaign trail, but their direct influence on the broader economy is limited.
For example, go back to 2009, when the Obama administration was in the White House and Democrats controlled Congress. Despite what appeared to be a clear path to healthcare policy, it still took over six years to make plans available to Americans. Trump campaigned on tax reform and a wall on our southern border. These policies were not implemented overnight either.
The bottom line
Emotions are what distinguishes us from machines. They are why we can love, laugh, and smile, and they also keep us safe from harm (a scary noise in a dark alley causes the body’s senses to heighten for survival).
As important as it is to embrace these powerful forces, emotions also wreak havoc on our decisions. Recall the last time your emotions got the best of you, resulting in a decision void of logic and reasoning. Was the outcome favorable?
Recently, I woke up in a hotel room and stubbed my toe on a poorly placed coffee table. I got so mad at this inanimate object that I slammed my fist down upon it to teach it a lesson. Had I only stopped for a moment to assess the situation, I would have realized that this coffee table would probably not learn the error of its ways, and my wrist could have been spared days of avoidable pain.
Few emotions are stronger and impact decisions more than political ones, and the examples above show how politics can create unnecessary risk. For example, had an investor who feared for the future of America sold into the panic after Obama won his reelection, think about the gains this investor would have missed. The same goes for Trump’s victory in 2016.
That’s not to say investors should ignore politics. Active portfolio management must always pay close attention to D.C. because they set the rules. The key to success is to assess all possible outcomes from an election or policy change, determine the impact of each (without injecting one’s political beliefs), and then formulate a plan that attempts to profit in each outcome. That way, an investor can prepare for most scenarios and mitigate the risk of an emotionally fueled decision.
The bottom line is that the real risk to investors is not who wins next year but how one reacts to the outcome. The election does matter, but it’s only one input. Several others have little to do with politics, and these probably won’t change much after the election.
Sources
1 The Psychology of Misjudgment. By Charlie Munger
2 Bloomberg
Disclosures
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.