A Presidential Election Cycle?
With the US Presidential election over, the focus of investors naturally turns toward the outlook for stocks.
In the United States, debate about a so-called “Presidential election cycle” has raged for years. The theory posits that Wall Street tends to do better in Presidential pre-election and election years, and worst in the first post-election year. This is based on the view that Presidents tend to pump up the economy to ensure their re-election (or that of their party’s new candidate) and then re-apply the brakes in the year after winning office.
As seen in the chart below, election years tended to particularly boost stocks earlier last century, and there is some evidence that over the 1960s to 1990s, stocks in pre-election and election years tended to perform better than in post-election years.
That said, there is some evidence to suggest that post-election year market performance has tended to improve in recent cycles, especially compared to the performance during election years.
Indeed, as seen in the chart below, over the past 8 election cycles, the post-election year has produced the strongest performance, even if we exclude the 2008 election cycle (in which US stocks slumped by 38% during the election year). Excluding the 2008 cycle, average gains in the post-election year have been 15.6% compared with average gains of only 9.3% in election years.
This suggests that rather than Presidents influencing the economy to their advantage (which accounts for the Presidential cycle theory), the evidence more so suggests that elections tend to dampen market gains due to uncertainty, with a bounce back then more likely in the post-election year as such uncertainty is unwound.
What About Trump?
With regard to President Trump specifically, the big issue is whether he will strike a more moderate tone now that he has won. My expectation is that many of his more outlandish policies (like buidling a wall along the border with Mexico or slapping punitive tariffs on China) were more symbolic in nature, merely designed to gain media attention and votes. Indeed, his victory speech was much more moderate in tone, which helped lifted US stocks overnight.
Trump’s great political challenge will be to appease the desires of his “silent majority” base of support, without derailing the economy. On that score, a counter-productive all out trade war therefore seems unlikely, though a tougher stance with regard to trade and immigration issues should be expected. This should be of some relief to investors fearing a negative impact on international trade.
More positively, markets are now likely to focus on the prospects of significant fiscal expansion, especially given the Republicans have majorities in both houses of Congress. Indeed, given many elected members of Congress owe their seats to the Trump swing, they are unlikely to be as obstructionist as they would have been had Hillary Clinton become President.
Trump has promised to cut taxes and boost spending on infrastructure and defence, which would be bearish for bond markets but bullish for the US dollar. While a short-term relief rally is likely, and notwithstanding the historical evidence above, the overall outlook for US equities in 2017 is challenged, however, by already high price-earnings valuations and the prospect of higher bond yields.
Within the US equity market, a rotation toward sectors favoured by Trump’s policies – and rising bond yields – seems likely, which would include health care, defense, construction and banks. Sectors most likely to be disadvantaged are those that have benefited from the decline in bond yields in recent years, such as listed property and utilties.