In the investment world, a huge variety of factors can move markets. Most of these relate directly to economic and business conditions, but political developments are often conflated with market-moving forces, even in cases of time-worn political debates. Investors are usually well served by not reacting to political headlines, but that can be easier said than done.
This article will explore the ways in which politics may or may not impact markets, ranging from discrete events (elections) to longer-term political movements.
Financial Implications of Elections
Elections are important, but not always for the reasons that people expect.
As political victors like to remind their opponents, elections have consequences. The outcomes of elections, from local school board to the White House, can indeed have wide-ranging impacts on our lives. To do our civic duty, it’s important for all of us to have a clear understanding of the moral, philosophical, and practical issues at stake when we go into the voting booth.
The importance of civic engagement, however, tends not to translate very well to investment portfolios. Politics has less of an effect on the economy and the markets than we think. Since 1900, according to Bespoke Research, the average gain for the Dow Jones Industrial Average has been 4.8 percent per year, reflecting steady progress across the economy as a whole. Decade after decade, markets have moved ahead as the economy grew, regardless of the party in power.
When we do see a political influence, it is not what some might expect.
The average Republican administration over that time period saw gains of 3.5 percent per year, while the Democrats saw gains of almost twice as much, at 6.7 percent per year. Recent decades have seen the same pattern, with annual gains under Clinton and Obama exceeding those of both Bushes and Trump.
Put in that context, speculation about the investment impact of elections tends to be overstated. The U.S. economy and markets are much bigger than any one president or political party. In general, political leaders receive too much credit and/or blame for what happens in the economy and markets, which are usually influenced more heavily by factors out of their control.
Image: A hypothetical $10,000 investment in the S&P 500 Index in 1961 would have grown to more than $3 million as of 9/30/20. Source.
The Financial Impact of Politics Over Time
Although every political character is different, Republicans tend to run on platforms of largescale tax cuts, while Democrats focus on increased spending to fund various programs. Either party may pay lip service to balancing the budget but have rarely taken concrete steps to do so. This is the normal ebb and flow of the politics.
In hindsight, it is easy to see the normal ebb and flow of political agendas. In the moment, however, it hardly seems normal when both sides consistently make any proposed political change look as apocalyptic as possible in hopes of motivating their donors and voters. The headlines that point out these likely changes are designed to get maximum attention by maximizing the perceived consequences.
The reality, however, is usually much less scary. Regardless of political sea changes, the checks and balances that are a part of our government tend to dull the sharp edges of radical changes. For better or worse, the American political system is designed to be hard to change, regardless of who wins one election or another. Investors should focus on what actually happens, rather than on whatever disaster the headlines are peddling on any given day.
How do Policy Changes Affect the Economy?
Despite the general resilience of businesses and markets to changes in political leadership, it can be hard not to react to specific policies.
On any given day, you can expect to read or hear about some significant policy change that is being proposed, debated, pushed through, defeated, or signed into law. When headlines are dominated by political developments, we always get questions from our clients about how their investments or financial plan will be impacted.
There’s no shortage of speculation about how a certain policy will affect one stock or another, or one industry or another. Some of these turn into very predictable debates. For example, when a tax change impacting the wealthy and corporations is proposed, there’s always a debate around whether such changes will have a “trickle-down” effect on the rest of the economy.
When the minimum wage is debated, it’s always a question of the benefit of a higher income to workers vs. the possibility that businesses will cut jobs due to higher labor costs. As predictable as these issues and the ensuing debates are, it’s not always easy to know how to react.
The more sweeping the change, the more difficult it is to discern a specific impact, particularly on the investment landscape. Largescale changes to tax rates, for example, tend to have an across-the-board impact, so it’s difficult to pick out one investment or another that will do particularly well or poorly.
At the same time, tax changes don’t fundamentally change the way that businesses operate in the US, so the market continues to grow over time. We’ve seen this consistently in the 21st century, as tax policy has shifted one way or another without having major market impacts.
That’s not to say that the market hasn’t been volatile, just that the volatility has been the result of larger external impacts (like the tech bubble, the financial crisis, economic recovery, and the pandemic) rather than political initiatives.
As political outcomes get more specific, such as regulation of certain industries, awarding of government contracts, and targeted stimulus spending, there is a higher probability that there will be a more discernible impact on the stock of a certain company or sector. But that doesn’t make it any easier for the average investor to profit.
Any market reaction that does occur tends to be baked into the market to reflect the probability of the outcome happening. For example, if the Pentagon announces plans for a major new fighter jet program, the stocks of Lockheed Martin and Boeing are likely to immediately jump as they both have the potential to win a lucrative new contract. Once the contract is awarded to one, we can expect the winner’s stock to jump higher and the loser’s stock to drop.
All of these market reactions happen immediately upon the news becoming public, so there is no way for an investor to get ahead of the market moves (unless they obtain information before the public, but trading on that information would be illegal).
As tempting as it may be to try, there is simply not a clear and legal way for an average investor to profit from political moves. Determining how policy changes will affect your investment portfolio is complicated, but perhaps that’s because the question itself is a bit misguided.
Rather than focusing on how you may take advantage of policy changes via the investment world, you should be more concerned with how changes will affect you personally, including your ability to save, draw income, and manage your tax bill. This is one of many cases where holistic financial planning is more important than investing.
When Political = Personal
The way to view political developments is not in terms of how some broad tax issue will affect one specific investment or another, but rather how changes specific to your assets and your income will affect the way that you plan for the future.
It’s about holistic planning, not speculative trading.
It’s easy to get caught up in the headline-grabbing political debates around tax overhauls, regulations, international treaties, and stimulus measures. And it makes sense that these get your attention, as they tend to be more interesting and more fiercely debated.
But the issues that have the biggest impact on personal finances are the ones that are, frankly, somewhat boring – programs for tuition assistance, provisions around Social Security, Required Minimum Distributions from retirement accounts, etc. These issues are more likely to affect you personally, not through your investments, but through your financial plan.
Even when confronted with something that is likely to affect your financial plan, it’s important not to act hastily – let the political process play out before reacting. No matter what side of the political spectrum they come from, examples abound of political pledges that have been subject to resistance from congress, alteration, dilution, and outright abandonment.
Just because a politician or a political candidate says they will do something doesn’t mean it will actually happen. For example, if a president says that he’d like certain college degrees to be free for certain individuals, some may be tempted to stop saving for their kids’ higher education expenses. But if the proposal doesn’t come to fruition, or if it gets radically changed in the process of becoming law, you could end up short-changing your kids’ future by relying too heavily on a political pledge.
What’s An Investor To Do?
In most cases, investors are served best by not reacting to political headlines. But if that’s the case, what are you supposed to do upon seeing the public firestorm that tends to accompany every political debate?
Perhaps the most important thing is to keep it all in perspective.
There are always important moral and philosophical issues at stake, and if there’s something that you care deeply about from that perspective, then you should find a productive way to join the debate and advocate for your views. Just don’t bring your finances into it unless there’s a clear and concrete way that your financial plan will be affected and needs to change.
