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Some observers characterize this Presidential election as the most important election ever, but that's been said before:
- In a July 2, 1888 editorial, The New York Times said of the Harrison vs. Cleveland presidential election: "The Republic is approaching what is to be on of the most important elections in its history."
- President Ford said during his Oct. 22, 1976 debate with Jimmy Carter: "I think this election is one of the most vital in the history of America".
- Ronald Regan described his race against Walter Mondale as "the most important election in this nation in 50 years."
So it should come as no surprise that this election is billed as "the most important election ever." But this one is not just about a quest for power, or money -- it's also about the economy. And for investors, it's about placing bets ahead of the results and hoping those stock picks do well in the aftermath.
So what's the market telling us? The overriding message is that it hates uncertainty. The economy has slowed down since the start of the year, thanks in part to soaring oil prices. Businesses have reacted by hiring fewer people than expected, giving smaller raises and bonuses. When workers, both consumers and investors, feel less secure about their jobs and their financial future, they become less optimistic and less likely to buy goods, services and equities. The Dow and the Nasdaq are down for the year, while the S&P is virtually flat. That usually bodes poorly for the incumbent, as voters generally assign credit or blame to White House for the economy's success or failure, even though most Presidents have little effect on the economy.
USA Today recently pointed out that the Dow Jones Industrial Average has posted positive returns in eight of the past 10 presidential election years. In 14 election years since 1948, the S&P 500 has gained an average of 9.3 percent, according to InvesTech Research. And while election year returns pale in comparison to the third year of the 4-year cycle, the gains will go a long way in repairing the damage to many a 401(k) balance.
So we have historical data showing that markets do well during presidential elections. When incumbents lose, we tend to see post-election rallies, as people adapt and rationalize the change. When incumbents win, it suggests the economy is pretty good and the markets then have a fundamental reason for rallying. Either way, people are happy with the direction of the country or the economy, or they're looking forward to a change.
What makes this such a difficult election to forecast is that we have no similar period of time with which to compare. We have never seen a Presidential term with a burst market bubble, a major recession and subsequent jobless recovery, a major terrorist attack on U.S. soil, big tax cuts and wars in two regions - Afghanistan and Iraq - in addition to a global battle against and terrorism.
There are only three ways this election can turn out.
Conventional wisdom says Wall Street should perform better under a Republican administration, since that party is seen as favoring business interests. But figures from the Stock Traders Almanac show that the stock market performs better under Democrats than it does under Republicans. From the start of the 20th century until 1995, stocks gained an average of 10.5 percent when Democrats were in the White House, versus an 8.1 percent average yearly gain under a Republican administration. I left out the last half of the 1990s and the bear market of 2003, as that data would skew the numbers too much.
Stock market gains are only half the story. Inflation, the old bugaboo for fixed income securities such as bonds, tends to be higher under Democrats and lower under Republicans. So the better stock market performance under the Democrats is offset by a reduction in the purchasing power of the dollar.
Ideally, markets prefer the gridlock of a divided government because it forces both sides to the middle. The best stock markets of the past three decades have been under the Reagan and Clinton administrations. Reagan was a Republican president with a Democratic Congress, while Clinton was democrat with a Republican Congress. Pragmatic moderation is an effective economic policy. Hard core ideological approaches tend to be disastrous.
- Bush victory. For stocks, this is the most bullish scenario initially. Since 1900, the biggest gains in election years have come when an incumbent Republican wins a second term in the oval office. Ned Davis Research has calculated the median gain of 14.6 percent versus 8 percent for all elections. Experts attribute the bullish reaction to investors' preference for certainty and the fact that they don't have to worry about massive changes in policy.
- Too close to call, a la the 2000 election. Post-election disputes and litigation, potentially delaying the announcement of final results could throw the markets into a tizzy. This scenario injects greater uncertainty and therefore more volatility in stock prices. Investor are currently pricing in the re-election of Bush, so any change in the odds of such outcome will create even more turbulence.
- A Kerry victory would be most worrisome initially for investors as it suggests something has gone wrong with the economy or political environment and mean policy change. Remember change is hard and not particularly welcomed by investors.
The post-election economic reaction will be particularly important to the stock market. Unfulfilled campaign promises and curbs on government spending have meant a much more spotty performance for the markets in post-election years. In fact, stocks have risen only half of the time in the years following elections since 1941.
So what to do about the election? Wait for the dust to settle. Investing should be done with a long-term time horizon and risk tolerance in mind. After the election, the stock market will once again focus on profits and earnings -- the driving force behind capitalism.
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