The two major parties in U.S. politics have very different viewpoints and goals in American economic and social policy. It’s easy to think that the parties hold some sway in stock market performance when one or the other is in power. Is this true? Let’s look at some facts.
What Causes Stock Price Fluctuations
First, we want to look at what factors cause stock prices to fluctuate up and down. The drone view: it’s all about supply and demand. Market sentiment is the term used to describe causes of the fluctuation.
How does market demand rise and fall? There are many reasons for the demand for stocks to increase and result in higher prices:
● How investors feel about the economy. Is the economy slowing down, recovering, or booming? In an economic downturn, investors can panic and offload stocks before the price drops, which lessens demand. In a booming economy or one that is on the upswing, people are more likely to make more purchases, so the demand is higher.
● How investors feel about a particular industry. Remember the dot-com bubble of the 1990s? Anything to do with tech and internet startups was hot, driving up demand and pricing. That bubble eventually burst, but it is a good example of how interest in an industry can lead to market demand. Current examples are industries like electric cars, green energy, and crypto.
● How investors feel about the stock market. When the market appears to be on an upward trajectory, investors are more confident in stocks as a good investment. This can increase demand and cause prices to rise. The flip side of this is when the market drops, investors feel less confident and may sell or pause future purchases.
There can be changes in stock prices every day, every hour, and even every second! Billions of transactions happen on the market each trading day and the constantly changing price reflects that. While prices may fluctuate in the short term, long-term investors are more concerned with a stock's overall value.
Stock Markets and Elections
Many financial advisors agree that presidential and midterm election years can be the cause for a wild ride for investors. The market can be volatile and unpredictable in the months before and after an election. Stock prices drop in the second and third quarters of the year, just before the November polls.
What happens after the polls close and the results are in? The market rebounds. The Journal of Wealth Management study looked at the quarterly returns of the S&P 500 over a 63 year period and found that 90 percent of the time “the index has been positive in the fourth quarter of a midterm election year and the following two quarters.”
So, a review of history has shown that the market rises after the elections are over and the dust has settled. That is some good news. But we don’t want to base any decisions on past trends or try to time the market.
While elections do come into play for the ups and downs, there are other factors that increase the volatility of the market even more. Some components include:
● Inflation. High inflation can cause the price of consumer goods and services to rise. Because they have reduced purchasing power and less disposable income, consumers drop their spending. Business revenues and profits go down as well when people aren’t spending. Because a company or industry may have uncertainty and reduced profits, their stock prices reflect that. When inflation is up, so is market volatility and risk.
● Interest Rates. With higher inflation comes higher interest rates. It costs more for people, businesses, and financial institutions to borrow and loan money. These higher rates leave less money for consumers and investors to spend. Businesses may have to cut the goods and services they provide and lose out on potential earnings. This can bring their stock prices down. When interest rates fall, consumer spending is looser and businesses can expand to meet customer demand, driving stock prices up.
● Monetary Policy. The Federal Reserve, sometimes called The Fed, sets the monetary policy goals for the U.S. Their main goal is to keep the American economy stable while keeping unemployment and inflation down. They raise and lower interest rates based on what is happening in the economy to keep the economy on track. They may employ a tight or restrictive monetary policy when inflation is on the uptick and the economy is expanding too quickly. A loose or accommodative policy is used to help a struggling economy get back on its feet.
While presidential and midterm elections may affect the stock market in the short-term, those trials are temporary. More long-term concerns? Inflation, interest rates, and monetary policy.
What’s the Game Plan
So, what is your next move during an election year? While it is tempting to sell your home, cash in your portfolio, and move to a deserted island, there are fewer extreme things you can choose to do.
Don’t Panic. Regardless of who gets elected, what party is in power, or what the news is telling you, there is no reason to be afraid. Your investment portfolio was chosen and put into place with rational thought and good advice. Don’t abandon it now just because of an emotional response or irrational fear caused by conflicting messages from political parties or media.
Keep Informed. Read up on what’s happening in the market from trusted sources and stay connected to reliable financial advisors or mentors. Be aware of what the economy is doing, how certain industries are faring, and what is happening in your personal portfolio.
Stay the Course. Remember your goals and why you have invested. Long-term investors are looking five, ten, and twenty years ahead and taking the long view. Your investment strategy isn’t based on emotion and fear, but on solid choices for a portfolio that performs well, regardless of who is in office.
It’s natural to think that the political party in power has a direct effect on the market, but it’s good to remember that is hardly the case. Other factors play into stock price fluctuations and market volatility. The election year takeaway: keep the long view in sight and stay the course.