Note: Fisher Investments’ political commentary is intentionally nonpartisan. We favor no political party nor any politician and assess political developments solely for their potential economic and market impact.
Whenever an election approaches, no matter the country, Fisher Investments analysts see an abundance of commentary arguing the results will be make-or-break for markets. Most of it centers on the leading candidates’ personalities and traditional biases, painting some parties as inherently good for markets and others as bad. We saw it with last year’s US election, and now it surrounds the European elections taking place this year. In our view, however, it all misses a key point and risks leading investors astray as a result: Markets care about policies, not personalities, and the degree to which any changes are better or worse than generally expected.
In our view, US stock returns’ long history best shows this, as we can assess returns in the election and inaugural years of 24 presidential cycles. The election year is typically when markets register investors’ hopes or fears about the next president, while the inaugural year is when reality usually takes hold. In our experience, about two-thirds of US investors lean Republican and fear Democratic presidents will push policies that impede stocks. Accordingly, in election years when a Republican wins, high hopes propel average 15.2% annual returns.[i] But in years when a Democrat wins, fears knock average returns down to just 7.4%.[ii] (This excludes 2020, as having only Joe Biden’s election year and not his inaugural year would result in mismatched data sets.)
In the inaugural year, though, the truth emerges: All presidents, regardless of party, are just politicians. Not only do they have to do some horse trading and water down flagship campaign pledges in order to get legislation passed, many don’t even try to fulfill big pledges. Therefore, inaugural-year returns average just 2.6% under Republican presidents as investors’ disappointment sets in.[iii] But returns in Democratic presidents’ inaugural years improve to 16.2% as relief and falling uncertainty power markets higher.[iv] Over the full two-year stretch, though, there isn’t a huge difference between the parties: Returns average 18.0% when a Republican wins and 23.4% when a Democrat wins.[v] While it might be tempting to read into this, we don’t think that is useful, as politics is just one market driver. The vast majority of economic activity in the US and developed Europe emerges from the private sector, making economic drivers crucial.
Still, the presidential return history hints at a key point: Political biases often don’t match reality. The simple truth, worldwide, is that no political party is inherently good or bad for markets. None have the monopoly on policies that help or hurt publicly traded companies and the broader economy. In the US, some of the legislation we consider most unhelpful for stocks was bipartisan—for example, the Tariff Act of 1930 or 2002’s Sarbanes-Oxley Act. Republicans and Democrats alike have added and removed regulations and cut and raised taxes. The history in the UK is similar, leading British stocks to have periods of boom and bust under Labour and Conservative governments.
Therefore, instead of basing your political analysis around the party in charge, strip out biases and think about policies. As a general rule, markets dislike rising uncertainty and love falling uncertainty. On the political front, we think that means stocks get relatively more agitated when legislative uncertainty is high. That makes an active government, regardless of ideological creed, the primary political risk for stocks, in our view. Relatedly, the most bullish backdrop is political gridlock, which keeps legislative risk and uncertainty low.
This is difficult for many investors to fathom because political biases are so hard to turn off. Partisan investors on either side want their party to accomplish the agenda they voted for. Politicians generally sell their proposed policies to voters by touting the potential winners. But in our experience, all legislation creates losers as well as winners, bringing psychological forces into play. Behavioral scientists have demonstrated that when confronted with the prospect of gains and losses, the losing party feels the pain of potential loss significantly more than the winning party feels the joy of potential gain. Hence, if a legislature is active, the associated uncertainty can weigh on sentiment.
But that doesn’t render returns negative automatically. If investors broadly fear disruptive legislation and whatever passes is watered down relative to those expectations, that can be a good-enough surprise to help markets. We saw this in America in 2010, when President Barack Obama passed widely discussed healthcare and financial-reform bills. Both were large—but not as sweeping and radical as many politicians initially proposed. Investors were broadly relieved by this, contributing to positive US stock returns that year, in our view.
In Fisher Investments’ view, gridlock also explains why several European nations enjoyed positive returns even as populist parties entered government in recent years. That includes Italy, where the coalition formed by the anti-establishment Five Star Movement and nationalist League in 2017 sparked worldwide fears that the country would get a radical economic makeover and leave the eurozone. Instead, the coalition partners spent two years bickering and getting nothing done, and Italian stocks benefited from the falling uncertainty.
In Spain, fears perked when the leftist populist Podemos party entered government in January 2020, in a coalition with the center-left Social Democrats. But there, too, very little has happened. The government only just passed its first budget, and it was a watered-down version of initial proposals. Income tax rises were much smaller than originally outlined, and the government scrapped plans for a minimum corporate tax. Looking ahead, as the pandemic fades, it should clear the way for Spanish stocks to enjoy the tailwind of falling uncertainty as investors realize the coalition’s weakness.
Now, the above analysis applies most to developed nations. In the Emerging Markets sector, where there is frequently more state intervention in the economy and capital markets are less mature, Fisher Investments’ analysis suggests active, reform-minded governments can be positive factors for markets—and gridlock can prove to be a disappointment. Therefore, we think analyzing political drivers in that category requires much more nuance. But in developed Asia, Europe and North America, gridlock generally preserves a status quo that markets have dealt with for decades, giving investors one less thing to worry about.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: Global Financial Data, as of 10/04/2020. S&P 500 total returns, 12/31/1925–12/31/2019.
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