Everyone wants to know what will happen to the stock market as a result of next week’s U.S. Presidential election. There are countless ways to slice and dice the data – and it turns out, political predictions and portfolio positioning don’t mix well.
As you can see below, we had some fun testing various hypotheses which will hopefully help you drive the point home with your clients that their political predictions and their portfolio don’t necessarily need to align for them to experience potential long-term investing success.
Analysis #1: Explanatory power of a President’s political party affiliation
Since 1945, the average annual return for the S&P 500® Index has been:
With a Democratic President in office: +15.2%
With a Republican President in office: +10.0%
Regression analysis reveals that a President’s political party only explains 2.2% of the variation in stock market returns – quite a meaningless relationship
. This lack of relationship becomes even more obvious when we visualize the entire dataset, as shown in the chart below. The historically higher average return under Democratic Presidents is actually a statistical fluke. Republican Presidents’ average historical return was dragged down by a couple of exceptionally negative market performance years.
As of September 30, 2016
Next up, we conducted some analyses that wound up showing meaningful relationships, but their lack of predictability and timing sensitivity make them not very actionable for typical investors.
Analysis #2: Direction of interest rates and market returns
We found that when interest rates are falling, the stock market tends to do better. This is meaningful
and it is intuitive. When rates are low, it costs less for businesses to make capital investments in their companies, which helps earnings growth. But interest rates are difficult to predict. Think of all the economists who have been forecasting a rise in U.S. interest rates for the past two years! So caution to those investors who attempt to make investment decisions based on the meaningful statistical relationship between the direction of interest rates and market returns.
Analysis #3: Corporate earnings growth and market returns
Likewise, corporate earnings growth has a meaningful
impact on stock prices. The intuition is even more obvious in this case. When companies are growing their earnings at a higher than normal rate, they are worth more. But this relationship can be challenging to predict and implement – and is only one of many relevant inputs (e.g., time frame, risk budget, fee considerations) into forming an investment strategy.
Analysis #4: Valuations and market returns
There appears to be a meaningful
relationship between these variables, too. Valuations, or the relationship between earnings and price, has a significant influence and a well-documented impact on stock market returns. But again, this relationship is difficult to predict, so investors should be cautious about assessing how this variable fits in with the other relevant inputs, before implementing a change. Take the case of the U.S. equity market as an example: It has been considered by many to be overvalued for the last five years relative to other asset classes. Yet it continues to be one of the strongest performing markets globally.
To help drive home the point for clients that although relationships can be spotted almost everywhere, many are spurious – we ran some fun analyses, which revealed not meaningful and not actionable relationships.
Analysis #5: Relationship between the number of letters in a President’s surname and stock market returns
Ironically, the number of letters in a President’s last name has a higher explanatory power than a President’s political party, with each additional letter in the surname worth about 3.4% in average annual return. Clearly, there’s something else going on here – it’s ludicrous to propose that a President’s last name has anything to do with capital market returns. Indeed, this relationship is largely due to an average annual return of 16.8% during the two Eisenhower terms in the 1950s.
Analysis #6: Relationship between a President’s height, weight and eye color, and stock market returns
If we take into account the sitting President’s height, weight and eye color, we can explain even more of the variation in stock market returns. But, clearly these relationships are meaningless.
So what really matters? What is meaningful and actionable?
There are a few things that investors can do that can be truly meaningful and actionable. They won’t come as a surprise to advisors.
- Refresh long-term financial goals periodically to determine how much risk is appropriate to take when constructing investment portfolios.
- It may be beneficial to rebalance portfolio allocations to target weights by buying assets that have underperformed and trim assets that have outperformed.
The bottom line
Politics and punditry may be America’s favorite pastime, but the data shows that predicting Presidents and political parties has no place in priming personal portfolio positioning.