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Investing and Politics – Are They Connected?

Summary

The midterm results suggest there will be few policy changes in Washington during the next two years.

Last week’s midterm elections are a classic lesson in how difficult it is to predict the future. In late 2020, despite most polls suggesting a “blue wave” was imminent, we experienced what I then characterized as a “blue ripple,” with Democrats capturing the slimmest of majorities in both the House and Senate. Those razor-thin margins, we suggested then, would likely stunt any major policy changes. As one would expect with an almost evenly divided Congress, President Biden’s chief policy initiatives were either dialed back (e.g., Build Back Better) or shelved altogether (e.g., proposed tax increases, elimination of carried interest).

I think the same characterization applies now to what many pundits had claimed would be a “red wave”; last Tuesday’s midterms appear to have resulted in, at most, a “red ripple.” At the moment, it appears Congress will remain closely divided; Democrats have retained their slight majority in the Senate, and Republicans have claimed a slim majority in the House of Representatives.

 

Policy implications

For those who are either excited or concerned (or both!) about the prospect of future legislative change in Washington, you’d be wise to temper your expectations. These midterm results suggest that little real policy change will likely happen in the next two years. A Republican House will likely reject any major fiscal stimulus or change in tax policy; similarly, a Democratic Senate will likely reject any attempt to cut taxes or federal spending. In our view, given the current high state of economic uncertainty, maintaining the status quo on tax policy and government spending (i.e., legislative gridlock) is probably a good thing for markets right now.

 

Implications for investors

Investors are often tempted to make investment decisions based on their political views. History, however, strongly suggests we should vote with ballots and not with our portfolios. To that end, we believe there are three important takeaways for investors when it comes to elections and portfolios.

 

Don’t let how you feel about politics impact how you think about investing.

Survey data from Pew Research Center shows how Americans regard the economy. Republicans usually feel better about it with a Republican president, while Democrats usually feel better with a president from their party. Yet average annual returns during the Obama and Trump administrations were virtually identical—16.3% for Obama vs. 16.0% for Trump. What’s more, market returns under both administrations were higher than the 30-year average of 10.6%. Consequently, investors who let their political opinions overrule their investing discipline may have missed out on above-average returns during the administration they opposed.

Exhibit: Consumer confidence by political affiliation—percentage of Republicans and Democrats who rate national economic conditions as excellent or good

Source: Pew Research Center, J.P. Morgan Asset Management. Pew Research Center, June 2020. “Republicans, Democrats Move Even Further Apart in Coronavirus Concerns”. Question: Thinking about the nation’s economy, How would you rate economic conditions in this country today… as excellent, good, only fair, or poor? The survey was last conducted in July 2022. Guide to the Markets – U.S. Data are as of August 31, 2022.

 

Market returns have increased under both parties over time.

Despite what politicians would have us believe, there’s no reliable evidence that either party is better than the other for financial markets. Things such as valuation, interest rate, GDP growth, geopolitical events, demographic developments, and technological innovation arguably have greater influence on market returns than any legislation from Capitol Hill.

Exhibit: Hypothetical growth of $1 invested in the S&P 500 Index, and party control of Congress, January 1926–December 2021

Source: S&P data © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved

For illustrative purposes only.

 

Markets hate uncertainty—and elections tend to reduce it.

Market returns have, on average, been higher in nonelection years (11.9%) than in election years (5.4% for midterm, 6.4% for presidential). What’s more, market volatility (risk) has also been lower during nonelection years (12.9%) than in election years (15.7% for midterm, 14.8% for presidential).

But investors should be careful: Averages can be deceiving, and the variation in return from one year to the next strongly cautions against trying to time market returns based on election years. Markets have done well over the long term. Rather than seeking to time their market returns, investors should focus on maximizing their time in markets. The lesson for investors is that the best time to invest is when you have the money. The best time to sell is when you need the money. Politics, regardless of one’s views, should never factor into either decision.

Exhibit: Returns and volatility during election years

Source: S&P data © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

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