How Elections Impact Stocks and the Economy

Elections happen at different levels of government in the United States, each one joined by its own set of impacts. In terms of the general economy and stock market, however, the presidential election holds the greatest weight. Presidential elections generate quite a bit of commotion, and election years are full of uncertainty and can pressure investors out of the market into “safer” assets and also generate confusion about the economy.

While the election and the economy can often feel erratic, it’s important to remember that it’s not necessarily about the pros and cons of a red or blue administration. Let’s take a look at the impact on economic and stock market performance during election years.

The Effect On the Economy

In a presidential campaign, much attention is thrust upon the candidates and incumbent administration, and conversation is concentrated on the state of the economy. Presidents have some tools at their disposal to move the economy, namely fiscal policy, which refers to the use of government spending and tax policies to influence economic conditions.

Monetary policy, the sibling of fiscal policy, is easily mistaken here, but the two are quite different. Monetary policy is independent of the president and under the responsibility of the Federal Reserve. Because of this, it’s less affected during election years but does experience some turbulence.

Historically, presidential election years have seen a consistent theme of adjustments to fiscal policy. These adjustments typically include increased spending and decreased revenue (taxes). Studies conducted by the International Monetary Fund show that fiscal policy tends to be looser and slippages larger during election years.¹ Slippages here refer to the difference in expected versus actual government expenditures/revenues. Incumbent administrations might loosen fiscal policy during election years for the following reasons:

Increased Spending—Some budget items might experience an increase in spending during an election year for several reasons. One reason for increased spending could be to increase public approval, but unexpected world events and timing of policy approval can also impact government spending. Although difficult to narrow down why, there does seem to be a trend of increased spending during election years.

Decreased Revenue—Another apparent trend during election years is decreasing taxes. As part of loosening fiscal policy, a decrease in taxes can help with public approval ratings.

While incumbent administrations can propose fiscal policy changes, it still has to go through its process via executive and legislative branches of government. On top of that, monetary policy can use interest rates and other tools to influence economic conditions. While the Federal Reserve and its monetary policy decisions are less affected by presidential elections, the Fed may delay or quicken decisions based on economic and policy uncertainty.

These changes to fiscal policy can help stimulate the economy and increase public approval, but when looking at changes in GDP during election years, there isn’t a consistent pattern of growth. Some studies find a slight increase in growth on average due to an election year, while other studies find no meaningful, consistent impact on GDP growth. Election years stir up a lot of commotion, but the economy seems to grow, or decline based on much more than the timing of presidential elections—namely what the elected administration does once in office.

The Effect On the Stock Market

The stock market is forward-looking and moves day-to-day based on what investors believe the future holds. When that future is more or less difficult to predict, it can be assumed the stock market will experience more or less volatility.

The president has the power to impact the stock market via regulations, tax proposals, etc. Investors are affected by these “what-ifs” and are not always rational. Fear can grab hold and affect investment behavior, showing up as market volatility. The bulk of this turbulence is experienced months before the election though. Once presidential candidates are chosen during the primaries, the market usually experiences a cooldown in volatility. Although fluctuations in volatility are to be expected, there is no meaningful or consistent impact on stock market performance during presidential election years.

Source: Capital Group: Guide to investing in an election year

While strategies and beliefs differ across party lines and proposed policy can vary greatly, the data suggests the greatest return on investment comes from staying invested through changing political parties.² As the adage goes, time in the market beats timing the market. Made evident with the graph above, the market’s long-term growth persists through Democratic and Republican presidencies.

This might help ease concerns of who becomes president and how the market might react during a red or blue administration, but we can also narrow our focus to the years of presidential elections. From 1960 to 2020, stocks have risen during 13 out of 16 election years.² This is a substantial piece of data, and although we shouldn’t make decisions solely based on precedent, this can ease expectations. Regardless of volatility and our intrinsic fear of uncertainty, history can provide some reassurance as to how the future might pan out.

Going Forward

These times bring out a lot of questions regarding the state of the economy, as candidates poke holes to make a case for their presidency and how they can fix the economy. However, those “safer” assets investors tend to seek during uncertainty have shown to be less advantageous than staying the course, and the economy doesn’t experience meaningful changes solely due to the election year.

Long-term investing is not without its ups and downs, but history does provide some reassurance. With the help of looking back in time and having an advisor by your side, these unpredictable times can be made less daunting.

Always feel free to reach out to a Resource Consulting Group advisor with any thoughts or questions.

1 Fiscal Policy in the Great Election Year

2 Staying Invested Through Election Years