Our nation’s unprecedented level of political controversy has amplified the fears of many investors. Typically, heightened investor fear equates to increased stock market volatility. But the market is on a record-setting trend… should you be worried?
People want to know: "How will the stock market react if President Trump does ‘x’?" or "How will it react if Congress doesn’t pass the income tax, estate tax, or healthcare reform?" Everyone is on edge. But is this current atmosphere of fear justified? Let’s step back and take a look at the historical correlation between political power and the stock market. Can it provide the answers?
What the Data and Research Suggest
A political research group, Pastor and Veronesi (P&V), recently released the results of its 2017 study on the correlation between political power and our U.S. stock market.
P&V’s report shows that from 1925 to 2015 the average market return under Democratic Party presidents is 10.7 percent per year, whereas under Republican Party presidents it’s negative 0.2 percent per year. Quick Math: That’s nearly an 11 percent difference in stock market return per year! This shows a high correlation between political party and stock market returns. But does it tell the full story?
Research Affiliates (RA) analyzed this data further. The two key findings from its study conclude:
- A Republican was president during the two great financial and economic crashes (1929 and 2008). Democratic Party presidents were in power during the subsequent recovery periods. That’s fact. But RA found that political party didn’t matter. Whichever party was in power during these financial crises, the other party would be voted in during the recovery period. That is cause for doubt as to the validity of the correlation.
- When RA conducted the same study in Germany, France, Canada, Australia, and the United Kingdom it found no correlation between their incumbent political parties and their stock market – and, therefore, no correlation to the U.S. data.
Our Interpretation of Both Research Groups
So what should we deduce from these two seemingly conflicting reports? Our primary take-away is that historical data can be manipulated based on small variables. When these variables are removed, the results can drastically change.
Second, globally speaking, it’s clear that the likelihood of markets moving in one direction or the other is not dependent on the political party in power at the moment. And, finally, historical data does not guarantee future data. That makes these particular findings irrelevant for predicting future stock market returns.
Trump X Factor: Should We Toss the Studies Out the Window?
We can all agree that President Trump is unlike any other U.S. President. Whether you support him or not, you must ask yourself one question as it relates to your investment portfolio: "Will Trump’s actions or policies impact the amount of iPhones Apple sells, boxes Amazon ships, widgets GE produces, tractors Caterpillar sells or the advertising revenue for Facebook and Google?"
If your answer is "yes," then the stock market might not be the best place for you during his presidential term. If your answer is "no," then we advise you to take a step back and trust your investment process and the financial plan you have established.
Political agendas come and go, but the stock market has remained consistent over the long-term.
Our findings from these studies show little correlation, term-over-term, between political party power and global stock market returns. So if you find yourself disagreeing with a standing president, try to separate your personal political views from your investment portfolio decisions.
Evan D. Bedel, CFP, is the Director of Strategy and Finance at Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at BedelFinancial.com or email Evan.