This presidential election campaign season is filled with surprises—and that can be a challenge for investors. If there is one thing financial markets don’t do well with, it’s uncertainty. Uncertainty can lead to three of the most common investment mistakes:
- Buying at the top
- Selling at the bottom
- Changing long-term allocation strategies based on short-term events—such as the results of a presidential election
Now may be a good time for advisors to prepare their clients: Historical trends suggest that volatility is to be expected in the coming months.
A Newcomer Represents Change
When a two-term president departs from office—regardless of whether he was a Democrat or Republican—this change in government makes the future less predictable and the market responds with increased volatility.
By contrast, a review of the last six presidential election years shows that election years with an incumbent president seeking to be returned to office experience significantly higher returns and with less volatility. Since 1992, there have been four elections with an incumbent and two without.
During this time, the returns in an election year with a returning incumbent president (1992, 1996, 2004 and 2012) were an average 36% higher than when an incumbent was not seeking re-election (2000 and 2008). Volatility was 11% lower, on average, during the years when an incumbent was seeking re-election.
Democrats Have the Market Edge
What significance does party affiliation have to election year performance and volatility? Over the last seven presidential terms (1989-2015), Democrats have held the country’s top office four times and Republicans three. The markets during Democratic administration years returned an average 14% versus a 3% return during Republican administrations.
More than presidential transitions can influence the markets. As we know from this year alone, events like the Brexit vote can move the markets in unpredictable ways, and of course the markets will both anticipate and reflect current and projected economic conditions.
As financial advisors know, the best way to prepare for market volatility is for clients to maintain a long-term perspective. It’s important to stay focused on established investment goals and broader economic trends shaping both the U.S. and international—independent of the short-term political news.
For more on volatility, see our Volatility Opportunity Guide.