How Does an Election Year Impact Financial Markets?

Macroeconomic factors are broad economic indicators and conditions that can significantly impact financial markets. These factors reflect the overall health and performance of a country's economy and can influence various asset classes, including stocks, bonds, currencies, and commodities. There are numerous influencing factors, but for the purposes of this article, we will focus on GDP, inflation, and geopolitical events.

A crucial factor impacting financial markets is the rate of economic growth (GDP). Strong economic growth can boost corporate profits, consumer spending, and investor confidence, generally leading to higher stock prices.

Inflation, a second factor, can affect purchasing power and real returns on investments. Central banks often use interest rates to control inflation, which can influence bond yields and equity valuations.

Lastly, geopolitical tensions, conflicts, and events (such as an election) can create uncertainty and disrupt financial markets. Investors may seek safe-haven assets during times of geopolitical instability.

Financial markets can be influenced by many factors during an election year. While market reactions can vary depending on the specific election, the political climate, and economic conditions at the time, here are some common ways that financial markets can be impacted during election season.

Government Spending

In election years, incumbent governments often try to boost the economy through increased government spending or other stimulus measures to gain voter support. This can affect inflation, interest rates, and overall economic conditions, which in turn influence financial markets.

Regulatory Changes

Election outcomes can lead to shifts in regulatory priorities. For example, changes in financial market regulations can influence the behavior of financial institutions and the overall stability of financial markets.

Fiscal Policy

The fiscal policies of the elected government can impact government spending, taxation, and deficits. These items affect the bond market and currency exchange rates.

Healthcare and Pharmaceutical Sectors

Elections can influence the healthcare sector, especially when healthcare policy reforms are on the agenda. Changes in regulations, drug pricing policies, and insurance coverage can affect pharmaceutical and healthcare-related stocks.

Stock markets can exhibit varying levels of volatility during an election year. Whether they become more or less volatile depends on the specific election, the economic backdrop, and global events.

Elections often introduce a degree of increased uncertainty into the market because the outcome can lead to changes in economic policies, regulations, and government leadership. This uncertainty can lead to higher volatility as investors may react to new developments and information related to the election. Positive or negative news about a candidate's chances or their proposed policies can lead to rapid market movements.

The election outcome can also impact stock market volatility. The wining party or candidate's proposed policies and priorities can affect specific industries and sectors. Stock markets may become more volatile as investors try to anticipate the impact of these policies on companies and their earnings. The state of the economy during the election year can also affect volatility. If the economy is strong and stable, markets may be less volatile. Conversely, if economic conditions are uncertain or weak, markets may be more volatile as investors react to the election in the context of broader economic challenges.

Fiscal policies during an election year can influence inflation. Increased government spending, tax cuts, or other fiscal stimulus measures to boost the economy and gain voter support can stimulate economic growth in the short term. However, they may also put upward pressure on inflation if they lead to excessive demand for goods and services without a corresponding increase in supply.

Central banks, which are typically independent of political cycles, may adjust monetary policy in response to election-related economic conditions. If expansionary monetary policies (such as lowering interest rates or increasing money supply) are implemented to support economic growth during an election year, it can contribute to inflationary pressures.

Lastly, investor and consumer sentiment can be influenced by election-related developments, which can have an indirect impact on inflation. For example, if investors expect election outcomes to lead to significant changes in economic policies or increased uncertainty, they may alter their investment and spending behavior, which can affect the overall economic environment and inflation.

This chart illustrates the annual return for the S&P 500 in both the election year and the following year, beginning with the 1948 election. During election years, the average return was 10.72%, while the average return was 11.60% in the calendar year following an election. It's important to consider the factors that we've discussed in the article when looking at this chart -- for example, the dramatic loss in returns in 2008 was not directly in response to consumer sentiment to Obama being elected. External factors during this time, such as the housing crisis, most likely played a larger role in market volatility.

This chart shows the average annual growth in total returns from 1953 through December 2022 in relation to the administration's composition (Republicans and Democrats). Based on the data demonstrated in the chart, average annual growth in total returns was higher when Republicans held the majority in both the House and the Senate, regardless of the political party of the President. The average return for all years was 12.16%.

This chart demonstrates the average annual change in the inflation rate from 1953 through December 2022 in relation to the administration's political composition (Republicans and Democrats). Based on the data presented in the chart, the average annual change in inflation was higher when Democrats held the majority in both the House and the Senate, regardless of the political party of the President. The average change for all years was 3.54%.

The impact of an election on different types of investment accounts can vary depending o the specific election, the policies being debated, and the prevailing economic conditions.

Individual Stock Portfolios

Investors who hold individual stocks in their portfolios may be more directly impacted by election-related events, especially if certain sectors or companies are expected to be affected by changes in government policies. For example, healthcare stocks may be more sensitive to proposed healthcare reforms, while energy stocks may be influenced by energy and environmental policies.

ETFs

Sector-specific ETFs can be more directly impacted by election outcomes and related policy changes. Investors in these funds may experience greater volatility and price fluctuations if the sectors they track are affected by election-related developments.

Bond Portfolios

The bond market can also be influenced by elections, particularly if there are expectations of changes in fiscal policies or government debt issuance. Changes in interest rates and inflation expectations can impact the performance of different types of bonds. Long-term bonds are generally more sensitive to interest rate changes, and their prices may be more affected by election-related interest rate decisions.

Tax-Advantaged Accounts

Tax policies are often a significant focus during elections. Retirement accounts like 401(k)s and IRAs can be impacted by potential changes in tax laws. For example, alterations in contribution limits, tax deductions, or the taxation of retirement account distributions can affect investors in these accounts.

Real Estate Investments

Real estate investment trusts (REITs) and real estate crowdfunding investments can be influenced by election outcomes, especially if there are changes in tax policies, housing policies, or regulations that impact the real estate market.

Investing during an election year can be challenging due to increased uncertainty and potential market volatility. Here are some tips for you to consider during an election year.

• Stay informed. Keep yourself well-informed about the candidates, their policies, and the potential impact on various sectors and industries. Understanding the political landscape can help you anticipate potential market moves.
• Diversify your portfolio. Diversification is a key strategy in any market environment. Ensure your investment portfolio is well-diversified across asset classes and sector to spread risk -- this can help mitigate the impact of election-related market volatility.
• Stick to your investment plan. Don't let short-term election-related events derail your long-term investment strategy. Develop and adhere to a well-thought-out investment plan that aligns with your financial goals and risk tolerance.
• Avoid making emotional decisions. Emotional reactions to election-related news and market fluctuations can lead to poor investment decisions. Avoid making impulsive trades based on fear or excitement. Stick to your plan and stay disciplined.
• Review your portfolio. Periodically review your investment portfolio to ensure it remains aligned with your goals and consider rebalancing if your portfolio's asset allocation has drifted significantly from your target.
• Stay invested. Market timing is notoriously difficult, and missing out on strong market days can have a detrimental impact on long-term returns. Avoid the temptation to move in and out of the market based on election-related news.
• Consider tax implications. Be mindful of the potential tax consequences of your investment decisions, especially in light of potential changes in tax policies resulting from the election. Consult with a tax advisor to optimize your tax strategy.
• Expect volatility. Understand that election years often come with increased market volatility. Be mentally prepared for ups and downs in your portfolio, and avoid making rash decisions during volatile periods.
• Use Dollar-Cost Averaging. If you're concerned about market timing, consider implementing a dollar-cost averaging strategy. Invest a fixed amount of money at regular intervals, regardless of market conditions. This can help mitigate the impact of short-term market fluctuations.

An election year can introduce significant volatility in the financial markets, and changes in policies could impact your investment portfolio. If you'd like to learn more about how your portfolio could be impacted, you can reach out to your advisor. Or, if you're interested in working with Chicago Partners to develop an investment strategy for 2024, you can send us a message here.