Vulnerability of Stock Markets During Elections Times

Stock Markets around Elections

Surging on waves of excitement and sliding under burdens of panic, Stock Markets are precarious indicators of the economies of nations but accurate reflections of people’s sentiments. They’re shaken by any unexpected event that may or may not affect company fundamentals.

Election times, along with the uncertainty and conjecture that they encourage, play a significant role in determining stock market trends. There is also a major contention that the opposite is also true: since stock markets reflect the general sentiment among the public, they can be used to predict election outcomes.

Elections determine the future course of a nations’ economy as the propagated ideologies of the elected leaders take the form of new policies and laws governing the country’s trade, services and industry as well as its relations with foreign countries. It determines the country’s roadmap for income distribution and prosperity However, much of the volatility witnessed by stock markets are a result of investors reacting to political news and adopting the herd mentality.

As long as the results are in alignment with the expectations of the market, regardless of whether the propagated policies of the new representative are good or bad for the economy as a whole, markets don’t take much toll. However, any outcome contrary to the predictions is bound to plunge the indices.

Market shocks and the extent of their impacts on volatility can spring from a variety of events including the failure of an incumbent to be re-elected to office, alteration in political ideologies of the government, a victory by a slim margin and any other outcome that goes contrary to the expectations of the market.

Just as an economy is subjected to the fluctuations of the business cycle, it has been observed by countless researchers that the stock markets also experience “election cycles” wherein Stock Markets witness more than usual volatility during and around the election months. A theory by Nordhaus claims that, regardless of their political inclinations, incumbents try to initiate policies that help them re-win the upcoming elections. Hence, they try to boost economic performance during the latter part of their tenures through a strong fiscal and monetary stimulus. This creates a rally in the Stock Markets during the months leading up to the election. However, once a new (or the incumbent party) wins office, measures need to be taken to curb the rising inflation which creates bearish trends in the stock markets after the elections. Moreover, the first few years after an election might not witness bullish trends because the economy and the investors might still be adjusting to the new policies of the ruling party.

Furthermore, investors often act optimistic of the upcoming elections creating a rally, but their disappointment with the leaders’ inability to fulfil their promises takes a toll on the markets after elections. It has been observed that stock market returns are slightly lower than bond yields after the elections.

To summarise, political outcomes do not define market outcomes. While elections do have an impact on market returns in the short run, their performance tends to average out over the long-run. Markets favour no certain political party which can be further validated by analysing the US Stock Market data over the past 90 years. On an average, over the initial two months after a presidential election, the markets fare better following a Republican win experiencing a gain of about 8.5% than a Democratic win, that has shown to lead to returns of about 5.8%. However, in the long-run, the vast difference in returns between these figures diminishes to a minuscule percentage. After a full 4-year term, Republican presidencies yield returns of about 8.6% while an average return of 8.8% is experienced by other presidencies.

What needs to be in times of heightened volatility is strict adherence to a long-term strategy. Investors must focus on corporate earnings and company fundamentals to not indulge in panic selling or buying, with a herd mentality. They must understand if the factors driving market prices would hold significance in the long run. Maintaining a well-diversified portfolio can also help insulate investors from such short-term fluctuations. For the wise stock traders, this short-term fluctuation in prices can also serve as buying opportunities. Traders must keep a close watch on the candidate’s propagated ideology and analyse which sectors could be impacted if they were to win the elections. It is never the political news but always the true economic scenario-labour productivity, interest rates, the overall financial soundness and competency of company management that determine long-term returns.