With the campaign trail hot and the debates even hotter, it's anybody's guess who will become U.S. president. But one result that investors can almost count on? Market volatility. The market can be especially dynamic during presidential elections. In fact, history suggests that there is a correlation between the two.
The United States is one of the world's largest economies, so conditions here have an effect globally. In November, the country will elect a new president and usher in a new term for America. So how do the elections affect the market and investors like you? Let's take a look:
Uncertainty over the Election
The new president is still very much undetermined. And the lack of certainty likely won't help the markets, which have already suffered a bout of volatility this year. Jeff Hirsch, editor in chief of the Stock Traders' Almanac newsletter, said that election-related uncertainty does not help market volatility. Investors just do not like the upheaval of an open-ended race.
It's not just the overall market that can anticipate volatility. Individual sectors—for example, energy or pharmaceutical drugs—may suffer from election uncertainty as well. However, the volatility can smooth out after a candidate has been selected and platforms are presented. This is because investors will be able to determine which industries might benefit or suffer because of the election.
Uncertainty over the Incumbent President
Market volatility can also be affected by a lame-duck presidency. Historically, the market prefers incumbents who are seeking re-election because of the continuity they bring. But presidents are often less predictable in their final year compared with their previous years in office. Since they aren't running for re-election, lame-duck presidents often try to push through their favorite policy initiatives, making investors nervous.
If this election does create volatility, don't expect it to end with the inauguration, Even after a president has been elected, volatility can remain. That's because a new president's first year in office—the “honeymoon” period—can be just as unpredictable as the last year in office. During that first year, a new president and lawmakers, riding on a wave of optimism, may feel like they can push through legislation that would otherwise be unpopular with voters, such as increased taxes.
What to Do?
There is no magic formula for predicting how exactly an election will affect the market. Plus elections aren't the only factors that contribute to market developments. The best way for investors to prepare for election-related volatility is the same way they should prepare for volatility in general: to consider it from a long-term perspective. Stay focused on the long-term financial plan you've created with your financial advisor. Don't let election ballyhoo prompt you to react in fear, and if you need reassurance, talk with your advisor.
Sources
Bryan Borzykowski, “Why Markets Tend to Fall During a Presidential Election Year,” CNBC, January 13, 2016, www.cnbc.com/2016/01/13/why-markets-tend-to-fall-during-a-presidential-election-year.html.
Matthew Jerrell, “How Will the Presidential Election Impact Markets?” Investopedia, www.investopedia.com/articles/financial-advisors/022916/how-will-presidential-election-impact-markets.asp.
William Watts, “2016 Predictions: What Presidential Election Years Mean for Stocks,” MarketWatch, December 29, 2015, www.marketwatch.com/story/2016-predictions-what-presidential-election-years-mean-for-stocks-2015-12-29.
