Correlation is a statistical measure (expressed as a number) that describes the size and direction of a relationship between two or more variables. A correlation between variables, however, does not automatically mean that the change in one variable is the cause of the change in the values of the other variable.
Causation, on the other hand, indicates that one event is the result of the occurrence of the other event; i.e. there is a causal relationship between the two events. This is also referred to as cause and effect.
Now in layman terms, what does this mean? Well, whenever I watch my favourite hockey team, the Montreal Canadiens, play a game, I believe that if I wear their jersey, they will win. While I believe I am helping my team win, this is clearly not the case. No matter how often it happens, the fact that I am wearing their jersey has nothing to do with the outcome of the game. While there is correlation, there is no causation.
In investment circles, I don’t know which is more commonly debated; who will win the U.S. election or which candidate will have more of a positive or negative impact on the markets. There is also much discussion surrounding market performance in the year in which the election is held.
Putting policy and personalities aside, let’s examine the impact, coincident or otherwise, of a presidential election on U.S. stocks.
We examined the calendar year returns (including dividends) for the S&P 500 Index going back to WWII. Since 1945 there has been a clear stock market favourite at the party level. The S&P 500 Total Return Index averaged gains of 14.86% in years where the sitting president was a Democrat, and 10.01% when a Republican was in office. The average for all years 1945-2015 was 12.37%. Republicans have had the unfortunate circumstance of overseeing six of the worst calendar year returns. These results may have been due to specific policies but more likely it was as a result of the fundamental environment and more coincidental than causal.
“I'm very familiar with how people can confuse correlation with causation”
— Tim Ferriss
Markets are somewhat less enthusiastic in election years. The S&P 500 Index has posted an average return of 9.95%, including dividends during a year in which Americans elect a president. Years in which the incumbent was seeking re-election fared much better than years in which a new president must be elected; the difference between the two being an average gain of 14.30% for the former and 4.50% for the latter.
The stronger than average stock market performance data in the final year of a first term may be the reason the sitting president almost always wins re-election. On only two occasions since 1945 (excluding Lyndon B. Johnson and Gerald Ford), has a president not won re-election for a second four-year term.
Further, the weak stock market performance data in the final year of a second term would suggest that it is harder for the incumbent party to win re-election for a third successive term. Therefore, it is not surprising to note that only once since 1945 has one political party held the office of the President of the United States for three successive terms (Republicans 1981-1992, Ronald Reagan and George Bush Sr). To be fair, both the years 2000 and 2008, with returns of -9.03% and -36.55% respectively, came in the final year of a president’s second term, perhaps unjustly skewing the average lower. There were only six such instances since 1945, where a president was ineligible to run again due to completing his maximum second term in office.
In the first year of a president’s term the equity markets favour the incumbent political party over a change in the White House. If the ruling party maintained power, the first year of the new term returned an average of 15.41%. When there is a change in party, the first-year average return for the S&P 500 Index drops to 5.72%. However, when looking at the full four-year term, the returns are virtually the same regardless of political party, 12.68% and 12.35%, respectively. This would suggest that the first year of a party change is the worst year of the four. And regardless of the political party in power, the third year is the best year with an average return of 19.08%.
We would like to point out however, while all the debate on how the markets may perform given certain political outcomes makes for interesting conversation, it is for the time being, purely speculation. We can also argue as to the cause of market performance and whether politics plays any part. Sometimes it truly is coincidental.
The historical data would seem to suggest that the stock market return in 2020, would be above average. However, ultimately the performance will be driven by the same three factors as it is every other year; dividend yield, change in Price/Earnings Ratio and change in Earnings Growth. As always, we would encourage investors to focus on the fundamentals, not the coincidences.
A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.
Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.
The opinions expressed are those of Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Manulife Investment Management disclaims any responsibility to update such information. Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.
All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management Limited, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Unless otherwise specified, all data is sourced from Manulife Investment Management.
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