The Mid-Term Elections & Your Portfolio
As I answered the phone, it was Jimmy. He is a tough man who earned a living in every aspect of the oil field. As always, he was straight to the point.
Jimmy said, “I want to liquidate 40% of my portfolio prior to the mid-term elections. Certain races are making me nervous.”
Jimmy’s concern wasn’t surprising. However, positioning his portfolio was another matter.
Jimmy elaborated that he is tired of seeing the political ads and potential implications.
This is a common and important conversation we encounter: How much does politics drive the financial markets?
Politicians will assure you they have the heartbeat of world commerce in the palm of their hands. With a simple social media post, they move markets.
It’s a great sales pitch, but not reality.
Jimmy asked for facts.
I offered historical data from Capital Group in which they tracked the S&P 500 since 1931. It showed the index generates double-digit average annual total returns across both unified and split government scenarios over the long term.
Jimmy acknowledged long periods generate strong returns. However, he said in the world today, there seems to be more short-term volatility. This unnerved him.
Admittedly, there are plenty of sound bites competing for our attention. This makes it seem that markets are more volatile. As I used to remind my father, if the morning news says the unemployment figures are bad, and they repeat that statement ten times during the day, the unemployment figures have not gotten ten times worse. But it feels that way.
Then I shared data from U.S. Bank analyzing three-month average returns since 1948. If one political party controls the Presidency and Congress, the quarterly returns on average 2.42%. However, if we have mixed or divided control between the Presidency and Congress, returns still average 2.17%.
Jimmy listened and then said, “I’m expecting a big 10% type drop if the election surprises people.”
Although it is a possibility, it is not probable. The odds are that capitalism will continue to trudge forward, regardless of whether Republicans or Democrats control the White House or Congress.
Mid-term election years do experience unique intra-year volatility. However, understanding this should reinforce why long-term plans should remain unchanged. Historically, the first nine months of a mid-term election year experience increased market anxiety and below-average returns as investors react to the unknown.
However, since 1938 the S&P 500 has posted positive gains in 19 out of 20 cycles (95% of the time) in the 12 months following a mid-term election. This surprised Jimmy.
This rebound occurs regardless of which party wins. The catalyst is not the specific political outcome, but rather the removal of uncertainty. Once the election is behind us, businesses and investors adjust to the known political landscape and move forward.
An investor who alters their portfolio out of fear during a mid-term year risk selling at a temporary low point, missing a historically predictable recovery.
As we continued, I reminded Jimmy that attempting to time the market based on mid-term election predictions assumes that legislative outcomes can be precisely forecasted and that market reactions will be predictable. It sounds great in an academic lab, but the combination of the financial markets with the political machine does not produce a precise or mathematically predictable outcome.
Our conversation was very productive, but highlighted that humans are emotional which can toy with logical plans.
Allowing political biases to influence your investments is one of the most destructive behavioral investing traps. Studies consistently show investors become overly optimistic about the economy when their preferred party is in power and excessively pessimistic when the opposition takes control.
This emotional reaction leads to mistakes. Investors will concentrate bets based upon specific sectors, such as nuclear power or solar, thought to benefit if a political party wins. Conversely, we see people like Jimmy, sell out of stocks fearful the opposing party will bring massive changes after a landslide win.
Additionally, every time we trade, investors incur commissions, taxes, and opportunity cost.
The media loves it when they capture your attention as they get to sell more advertising. Wall Street loves it when you abandon solid long-term plans as it generates additional fees.
However, to paraphrase Warren Buffett, in successful investing, there are no additional points for an increased level of difficulty. Keeping things simple, disciplined, and patient will enhance your wallet.
Dave Sather is a Certified Financial Planner and the CEO of the Sather Financial Group, a fee-only investment management and strategic planning firm.
