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It’s possible that the aftermath of this year’s U.S. presidential election might play out negatively for the stock market as the fractious nature of voters might lead to social unrest and uncertainty, regardless of who wins.

Twinsterphoto/iStockPhoto / Getty Images

So much has happened already in 2020 that the U.S. presidential election campaign – a multi-year phenomenon that typically receives a lot of media attention and has significant implications for the stock market – has been put on the back burner. That could begin to change very quickly.

Presidential elections take place quadrennially on the first Tuesday after Nov. 1. This year, the election is scheduled for Nov. 3. In the past, many analysts have postulated that the stock market tends to follow the president’s spending patterns.

The president would typically clamp down on budgets and get debt under control in the first two years in office, resulting in generally weaker stock market performance.

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Then, the president would once again turn on the taps and increase spending either to get re-elected or to support his party’s nominee. The result was often a strong stock market in the final two years of the election cycle, including the election year itself.

There’s another factor that tends to affect stock market returns in election years: uncertainty. On average, the stock market would often stumble in late autumn because investors don’t know who is going to win the election – and investors don’t like uncertainty. The result is often a weaker October heading into the election compared with the average gain in October over the long-term.

Since 1950, the S&P 500 has produced an average loss of 0.7 per cent in October during election years. That compares with an average gain in October of 1.5 per cent, overall, in all years. It’s worth noting that the stock market has often turned positive in late October of election years once investors had become comfortable with the possible outcome of the election.

So, is the presidential election cycle still valid for the stock market? In examining a cycle trend, it’s important to establish a possible causation factor.

In the past, a change in government spending during the presidential cycle was a significant driver of stock market performance. But this causational factor is no longer valid. Governments don’t hold back on spending in the first two years after the election any more – regardless of the political party. Once the president is elected, money is spent from the get-go and doesn’t stop flowing.

Brooke Thackray, research analyst, Horizons ETFs (Canada) Inc.

PIERRE GAUTREAU/Handout

However, investor uncertainty heading into the presidential election is still a valid causational factor that can affect stock market performance. It’s a permanent feature of the democratic election process and often causes the stock market to decline heading into the election.

In the last presidential election in 2016, the S&P 500 started to lose ground in August. It wasn’t until two days before the election that the stock market started to find some stability; it then then rallied once Donald Trump was elected. In 2012, the S&P 500 peaked in September and headed lower until a few days after Barack Obama was elected for the second time. It then staged a multi-year rally.

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There’s no guarantee that this year will follow the same trend of a weaker stock market in September or October as we get closer to the election, but there are many factors to cause investor uncertainty. Will the next president raise or lower personal and corporate taxes? Will the president increase government spending to try and stimulate the economy ravaged by COVID-19? If there’s a second wave of infections in the autumn, will the election be postponed? The list goes on.

It’s possible that the aftermath of this year’s election might play out negatively for the stock market as the fractious nature of U.S. voters might lead to social unrest and uncertainty, regardless of who wins. The good news, though, is that the S&P 500 tends to perform well in November of election years. Since 1950, the S&P 500 has produced an average gain of 1.5 per cent in November during election years. Let’s hope that this part of the election cycle trend holds true.

Brooke Thackray is research analyst at Horizons ETFs (Canada) Inc. He focuses on technical analysis and seasonal investing.

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