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How will the US elections influence your portfolio?
20 Oct 2020
Stock markets generally trended down in September, with the MSCI World ending the month about 1.5% lower. In the United States (-1.9%) infections had already peaked in July. The decline in the number of new cases should have been a boon to the US economy, but the inability of Democrats and Republicans to agree on further fiscal stimulus, together with the US elections left markets nervous. While Europe (-1.4%) succeeded pretty well in containing the virus over the summer, some member states were showing signs of a second wave of infections as we approached autumn, which left its mark on the region’s valuation. Emerging Asia (+0.8%), which has been very successful in containing the spread of covid-19, had a stellar recovery in Q3 (+7.2%).
In this newsletter we are going to discuss how the US elections might influence your portfolio in the months to come. We won’t do this by making a qualitative analysis of this specific race for the White House, but rather by making a quantitative one of all the US elections since Herbert Hoover (1928).
We will start by taking a look at how stock markets behaved in the months surrounding an election. Here we see that overall markets tended to be anxious in the months leading up to an election, as shown by negative average excess returns (*). In general, markets lost about 5.5% (annualized) in the months leading up to the election, which is quite terrible considering the average annual excess return US investors earned over the last century amounted to 8.1%. Regardless of the outcome, markets tended to breathe a sigh of relief when the US president was finally chosen. During the election month and the month that followed markets rallied by 16.5% (annualized) on average.
Next, we’ll tackle the question whether stock returns are evenly distributed during each of the 4 years of the presidential cycle. In the graph below we will plot the annual performance of the election year, and the years leading up to that. We do this for the broad market (blue) as well as the size premium (gray). As a point of reference, we add a light blue line which is the average annual performance of the US stock market over the last century.
The graph clearly shows that returns are reliably larger during the second half of the president’s term than during the first half. Moreover, smaller companies also tended to earn most of their premium during the second half of the presidential cycle. A common explanation brought forward for this phenomenon is that fiscal policy is tightest during the early stages of the cycle and tends to become more accommodating towards the end as the incumbent president seeks to win favour of the public when he has to get re-elected. As fiscal stimulus tends to have a positive effect on the stock market this could be a plausible hypothesis.
On a relative basis September was a very good month for our funds. Vector Navigator returned 0.67% and Vector Flexible, which profited from its significant hedge (~55%) as well as the stock selection alpha, did even better (+1.27%).
Werner, Thierry & Nils
(*) Excess returns are calculated by subtracting the risk-free rate from the market return