Originally published: October 2020
During election season, a big portion of financial media news coverage shifts to presidential election outcomes.
These election seasons tend to be good for media ratings and clicks, but to what extent do they matter for investors? Does accurately predicting the result of a presidential election generate outperformance? Can we say a lot about the direction of the economy depending on which political party is in charge? This article takes a look at those questions.
In recent interviews on various podcasts and media channels, I frequently get asked about how the upcoming presidential election affects my investment outlook. So, let’s take a look at it in data-driven terms, rather than partisan or narrative-driven terms.
Presidential Elections and the Economy
Human nature tends to place a lot of emphasis on specific events, rather than multi-year processes. As a consequence, investors tend to assume that if a specific candidate, or more broadly a specific party wins, then various aspects of the economy will change suddenly.
However, underneath the surface, there are tons of other details. We tend to think of political history in terms of who was president, because we can put a face and a general political tone to that era, but congressional control plays a big part as well. A president that faces an opposing-party-controlled senate, for example, is a very different environment than if that president also has his party in charge of the senate.
This analysis emphasizes presidential terms, because that’s what I get the most questions about. But it’ll dive into other branches of the government later in the analysis section.
To start with, here is a chart of annualized U.S. GDP and federal debt growth by president, going back to the time of Jimmy Carter in the mid 1970’s:
Data Source: U.S. Bureau of Economic Analysis, U.S. Department of the Treasury
This analysis rounds to the nearest quarter, since GDP is measured quarterly. Presidents take office on January 20th, while this analysis starts from January 1st of that period. That affects approximately one-fourth of one quarter of a president’s normal time in office, which can be 16 or 32 quarters depending on if they serve one term or two terms. So, that time shift affects about 0.8%-1.5% of a president’s time in office, and is not very statistically significant.
In addition, the reported data currently go through Q2 2020, so there are still two reportable quarters left of President Trump’s current term. Q2 is widely recognized as the bottom of this recession, with a partial GDP rebound in Q3 (which is now over, but not yet reported), and an unclear outcome in Q4. So, it would be very unfair to President Trump and the Republican party in the chart to end the analysis on Q2 as the most recently reported official data, and therefore we need to estimate through the end of the current term.
The Federal Reserve’s FOMC currently estimates a -3.5% year-over-year change in Q4 2019 to Q4 2020 real GDP. Because we’re rebounding from a pandemic with a substantial degree of uncertainty, I gave the economy the benefit of the doubt and used -2.5% as my 2020 real GDP estimate for the table. This is more bullish than FOMC estimates, and benefits the results for Trump and the Republican party in this table, but only slightly.
By extension, I used -1% for my 2020 nominal GDP measurement, which also leans a bit towards a stronger economy than what the base case outcome is and thus gives an upward tilt to this term’s numbers. The overall annualized numbers are affected by about 100 basis points, or 0.1% on the table, so it’s not a huge swing either way.
Looking at the table, the U.S. economy had faster GDP growth under Democrat presidents, both in nominal terms and in CPI-adjusted terms, than under Republican presidents. Democrat presidents also oversaw less debt accumulation as a percentage of GDP than Republican presidents.
These things are always tricky, because specific recession timings play a big role. The sample size is small with just seven presidents over a four-and-a-half decade period.
If the dotcom bubble had popped a year or two earlier, or if the subprime mortgage crisis had popped a year or two later, it could have made a big difference to outcomes, but then again, it also could have affected who won the subsequent elections.
On the other hand, if we go back much further to get a larger sample size, the modern parties become quite different than today’s parties, and we need to switch to some different data sources, since some of the commonly-available charts by the St. Louis Fed don’t go back that far.
So, in addition to the summary table above, let’s break it down visually in the next sections, and go back a bit further.
GDP Growth
Here is real GDP in blue, and year-over-year percent change in real GDP in red, with the presidents starting with Carter annotated:
Chart Source: St. Louis Fed
This chart shows us a few things.
Firstly, real GDP goes up and to the right pretty steadily, while the rate-of-change fluctuates wildly based on the business cycle. This shows, in significant part, the role that chance plays in economic political analysis, at least as far as GDP is concerned.
Secondly, the red rate-of-change line shows the structural decline in GDP growth over the long-term. If I were to draw a 50-year red trend line for real GDP in year-over-year % change terms, it would be a downward slope, even before this pandemic. Demographics aged and slowed down, and the economy became very debt-burdened, and the natural outcome of this is slower GDP growth.
Federal Debt Growth
This chart shows federal debt as a percentage of GDP, with presidential administrations starting with Carter annotated. For this one, I color-coded it by presidential party:
Chart Source: St. Louis Fed
During this period from Carter onwards, two of three Democrat administrations presided over decreases in federal debt as a percentage of GDP, whereas the third one (Obama) oversaw a large increase during his first term, which stabilized in his second term. The four Republican administrations all presided over large increases in the federal debt as a percentage of GDP.
We can take it back a lot further for context, though. Here’s a chart from my recent article that looked back century in multiple data sets, with federal debt as a percentage of GDP in blue:
Data Sources: U.S. Treasury Department, U.S. Federal Reserve
After World War I, federal debt as a percentage of GDP began decreasing under Republican presidents Harding (R) and Coolidge (R).
From there, Hoover (R) took office a few months before the 1929 crash and the start of the Great Depression, so federal debt as a percentage of GDP went up quite notably under his administration. Roosevelt (D) took over in 1933 and served 12 years (the longest of any U.S. president), and oversaw the rest of the Great Depression and World War II, where federal debt as a percentage of GDP increased by a lot as well.
After World War II, federal debt as a percent of GDP reversed and kept going down under both Democrat and Republican presidents from a combination of growth and inflation. Truman (D), Eisenhower (R), Kennedy (D), and Johnson (D) all presided over decreasing federal debt as a percentage of GDP. Nixon (R) presided over a smaller decrease, and his successor Ford (R) oversaw a mild increase. Under Carter (D), debt as a percentage of GDP went back to decreasing mildly.
Beginning with Reagan (R), federal debt as a percentage of GDP began moving up quickly, after a multi-decade downward trend. This marked a generational turning point in U.S. fiscal history away from decades of fiscal austerity and towards rapid debt accumulation, which was very popular.
Debt accumulation as a percentage of GDP continued under Bush Sr (R), but then began decreasing as a percent of GDP under Clinton (D). However, with the popping of the dotcom bubble, tax cuts, and the wars in the Middle East, debt as a percentage of GDP increased under Bush Jr (R), and that period culminated in the subprime mortgage crisis where federal debt began increasing rapidly. This debt increase continued under the first term of Obama (D) but then stabilized by his second term.
Debt as a percentage of GDP continued to be stable under the first two years under Trump (R), but began mildly increasing after the tax cuts, and blew out when the pandemic hit the economy, and the subsequent bipartisan stimulus that was passed to address it.
Crises Affect the Long-Term Numbers
Crises, especially at a time when private debt is already unusually high, tend to be the catalysts for rapid federal debt accumulation.
Under Hoover (R) and Roosevelt (D), for the Great Depression and World War II, federal debt skyrocketed, but then was reduced by both Democrats and Republicans in the following decades until 1980 when it started going back up under Reagan (R).
Debt skyrocketed again under the end of the presidency of Bush Jr (R) and the early presidency of Obama (D), as the Great Recession landed right during the transition between those administrations. The pandemic under Trump’s (R) current administration brought federal debt another leg higher as well, and will likely continue (at a less rapid pace) into either his second term or Biden’s (D) term, depending on who wins.
Federal Receipts and Outlays
This chart shows federal spending as a percentage of GDP in blue, and federal receipts as a percentage of GDP in red:
Chart Source: St. Louis Fed
In the post-WWII austerity era, this was in a very tight band, with both outlays and receipts remaining near the center of a 15-20% range. In other words, both federal spending and federal receipts averaged about 17% of GDP with minor fluctuations.
Starting in the 1970’s and continuing through most decades until the present day, however, spending jumped to the 20-25% of GDP band. Medicare was introduced, the Vietnam War was fought, and the global monetary order shifted from the Bretton Woods system to the Petrodollar system.
Overall, federal receipts as a percentage of GDP changed surprisingly little in 75 years, and is almost always within the 15-20% band of GDP. Meanwhile, spending fluctuated a bit more, from 15-25% of GDP, with the high-end of that range being reached in the 1970’s, 1980’s, and 2010’s. The 2020 pandemic then blew that historic spending band wide open; it hasn’t been since World War II that we’ve had deficits this big.
For most of history, it takes rather small changes in federal receipts and outlays, as well as inflation, to either rack up debt or reduce debt as a percentage of GDP, but crises and the unfolding of long-term debt cycles, can quickly blow those deficits out.
Presidential Elections and Stock Market Performance
The Wilshire 5000 is the broadest index of U.S. equities, including both large caps and small caps. Large caps represent well over three quarters of the index.
This table shows annualized Wilshire performance (including reinvested dividends) during each modern presidency starting with Carter:
Chart Source: Wilshire Associates, via St. Louis Fed
It’s debatable whether this should begin from when a president is elected or when a president takes office 2.5 months later, so I included both. When they are elected, the market starts pricing in their policy proposals, but those proposals don’t begin until after they get inaugurated and start influencing government policy.
The election occurs in early November and the inauguration occurs in late January. The data set is monthly, so for the election returns, it goes from the beginning of November (a few days prior to election), and for the inauguration returns, it goes from the beginning of February (about 11 days after inauguration).
During this 44-year period (with a sample size of just seven presidents), Democrat presidents oversaw much higher annualized stock gains. However, recession timing played a significant role in outcomes.
This chart shows annualized Wilshire performance (including reinvested dividends) in log form by president (at time of election):
Chart Source: St. Louis Fed
If we look back further than that, over the past century with the Dow or S&P 500 as the data set instead of the Wilshire which doesn’t go back that far, returns under Coolidge (R) were good, returns under Hoover (R) were poor, returns under Roosevelt (D) were good, returns under Truman (D) were good, returns under Eisenhower (R) were good, returns under Kennedy (D) and Johnson (D) were good, and returns under Nixon (R) and Ford (R) were poor, and from there we are back to Jimmy Carter (D) and the chart above with all modern presidents.
That’s about a century of returns, with Democrat administrations outperforming on average. The difference was mainly attributable to a handful of administrations where returns happened to be very poor, such as Hoover (R), Nixon/Ford (R), and Bush Jr (R), whereas both Democrat and Republican administrations had plenty of good return periods each.
However, when we go back in history like that, the parties are very different from today. The top tax rate under Eisenhower (R) was 91% and he authorized the biggest public works project in history; the U.S. interstate highway system. Meanwhile, the Environmental Protection Agency was founded under Nixon (R). The top tax rate went down under Kennedy (D). It becomes a different political landscape when we go back much beyond 4-5 decades.
Historically, forward equity performance is tied a lot more closely to equity valuations than presidential party.
I showed in a recent newsletter, for example, that household equity allocations as a % of total assets (which tend to be very high during highly-valued markets) are strongly inversely correlated with forward 10-year equity performance
Data Sources: Federal Reserve, Aswath Damodaran (NYU)
Similarly, the cyclically-adjusted earnings yield of the stock market (for which a lower number means higher-valued stocks) is very correlated with forward 10-year equity performance. In other words, when stocks are expensive with low earnings yields, forward returns tend to stagnate:
Data Sources: Aswath Damodaran (NYU), Robert Shiller (Yale)
So, regardless of who wins this presidential election, 10-year S&P 500 annualized returns are unlikely to be very high over the next decade, especially in inflation-adjusted terms, although anything is possible. We’re starting from fully-valued stocks, and they’ve been fully-valued by many metrics since 2017.
There will be plenty of good-performing stocks over the next decade of course, and we could very well see some major sector rotations under the surface.
Presidential Elections and Sentiment
Pew Research Center provides useful polls on the sentiment of the population in regards to the economy, including along partisan lines.
Chart Source: Pew Research Center
Under Clinton’s presidency, both Democrats and Republicans rated the economy increasingly well with no partisanship in their opinion. During the middle of Bush Jr’s time in office, Republicans rated the economy much stronger than Democrats. During Obama’s term in the aftermath of the subprime mortgage crisis, folks of both parties rated it as weak-but-improving, although Republicans rated it worse.
During the Obama-to-Trump transition, Republican perceptions of the economy jumped dramatically in the chart above, whereas Democrat perceptions of the economy decreased moderately.
As previous charts showed, however, GDP trend growth didn’t change much in absolute or rate-of-change terms during that Obama-to-Trump transition period. If there were no dates attached to the GDP chart, it would be tough to identify where the Obama Administration ended and the Trump administration began. The same is true for the unemployment rate. It was the recessions in 2008/2009 and 2020 that affected GDP growth, and that time between recessions was pretty much a straight trend.
Chart Source: St. Louis Fed
So, for about 15-20 years now, during the Bush administration, Obama administration, and Trump administration, people on both sides of the aisle have let political partisanship color their view of the economy, more than they used to.
Interestingly, Pew found that as federal deficits and debt grew over the past two years, Americans became less concerned, rather than more concerned, about those deficits and debt levels. Back in 2018, 55% of Americans considered the federal deficit to be a very big problem. However, after the deficit increased in 2019, only 53% of people thought it was a very big problem. When the pandemic hit and deficits blew out to highs not seen since World War II in 2020, only 47% of Americans considered it to be a very big problem.
Chart Source: Pew Research Center
Key Takeaways
There are all sorts of differences between presidential candidates, including Supreme Court nominations, tax rate changes on various income groups, foreign policy, social policy, healthcare policy, etc. Elections certainly matter for a country and people should vote their values one way or another.
However, the ability to generate investment outperformance from predicting election results is unclear. If anything, analyzing the situation through a partisan lens has a similar chance of hurting returns compared to improving returns.
Going back to the 1970’s, annualized stock returns and annualized real GDP growth have been stronger under Democrat administrations, while annualized federal debt growth has been bigger under Republican administrations. However, the timing of recessions, different starting points in stock valuations, and other factors strongly influence those numbers.
The next administration, whether it’s a continuation of the current one or a new one, probably faces one of the more troubled 4-year periods for these numbers, with the prospect of large fiscal deficits, rising debt-to-GDP, and historically high stock valuations that might pressure forward returns.
There are a few takeaways I have from this research. Readers might come up with their own takeaways as well.
Predictions are Hard to Profit From
Back when Hillary Clinton and Donald Trump were campaigning against each other, with Clinton leading in the polls, the narrative at the time was that if Trump unexpectedly won, markets would fall due to perceived instability. When he won, stock futures briefly dipped at the unexpected news, and then soared. Investors rightly began pricing in corporate tax cuts.
The pre-election narrative was wrong on both counts: first in terms of who would win, and secondly in terms of what would happen upon the outcome.
For a while, the narrative seems to have been that if Biden defeats Trump, the market will decline on fears of higher taxes, although in recent weeks that perception seems to have eased.
We’ll see who wins, and what happens when they win. Predicting market behavior around the election is hard; in order to be “right for the right reason”, first you have to be right about the outcome of the election, and then you have to be right about market reaction to the outcome of the election. If you have a 50/50 chance for both of those guesses, your probability of getting both right is 25%.
If you have a political specialty that gives you better odds of prediction, feel free to go for it, but it doesn’t seem to be extremely helpful for generating investment outperformance.
The Congressional Outcome Matters
Joe Biden is currently leading in the polls. It’s unclear if he’ll win the electoral college, and unclear if the U.S. Senate will end up tilted red or blue.
In my view, too much financial media emphasis is placed on the presidential election outcome of this race, and not enough is placed on which party takes control of the U.S. Senate, when it comes to how they could affect the economy and markets.
There’s a notable difference between Biden winning and the Senate turning blue along with him, than Biden winning and the Senate staying red, for example. The same is true for a Trump victory with the Senate staying red, and a Trump victory with a Senate that surprisingly shifts blue.
With a blue House, blue Senate, and blue President, we can expect certain changes, like an increase in taxes at the high end of the income spectrum, potentially an uptick in anti-trust activity against big tech, and more spending on renewable energy, for starters. We could also see an increase in corporate taxes, but potentially more aid to the working class and middle class and states.
With a blue House, red Senate, and red President, taxes are likely to stay low, and the prospect for infrastructure spending is decent. Spending might be a bit less than the first scenario, but it’s unclear if deficits (considering both spending and taxes) would be higher or lower.
However, with a blue House, red Senate, and blue President, the outcome is less decisive. Fiscal spending and tax changes could both be gridlocked. Gridlock reduces the probability of changes happening, which keeps things at the state they are currently in, meaning low taxes, and unclear spending outcomes.
In my view, based on where we are in the long-term debt cycle and the large economic shock we currently have, fiscal deficits are likely to be large under either blue-sweep or red-sweep outcomes, but could take different shapes depending on those outcomes (e.g. more stimulus spending, or more tax cuts). On the other hand, the prospect for somewhat lower deficits could occur if the President and Senate are of conflicting parties, and from there we’d have to see what happens in the 2022 mid-term election.
Focus on Specific Policies
We’re in a very macro-heavy environment, so ignoring politics entirely is unhelpful. However, rather than focusing on names and narratives, the impact to market performance depends in part on specific policies.
Corporate tax changes matter. Personal tax changes matter. Stimulus or lack thereof matters. Trade policy matters. Anti-trust activity matters. Especially on individual stocks and sectors.
Some of this could balance out from a stock market standpoint. A blue sweep in this environment, for example, increases the odds of higher corporate taxes and anti-trust activity (probably weak for stocks, especially tech) but also larger stimulus (probably good for stocks, especially among the value factor). A red hold, on the other hand, likely results in corporate taxes and anti-trust activity staying low (probably good for stocks, especially tech) and smaller stimulus (probably weak for stocks, especially among the value factor, although the pandemic impact should subside over time).
Deficits are likely to be very large over the next 4 years, regardless of who wins, although the specific composition of that deficit (tax changes and spending changes) would likely differ somewhat.
Fiscal stimulus or lack thereof, in the form of spending or tax cuts, and the magnitude of it, factors greatly into the inflation/deflation situation, and thus affects multiple asset classes. For example, broad money supply went up 24% this year, and personal income went up rather than down during a year with the worst unemployment shock in 90 years, as a result of fiscal stimulus to combat the pandemic’s impact on the economy:
Chart Source: St. Louis Fed
When it comes to modeling forward cash flows of cyclical businesses, or making estimates for inflation rates that affect bond yields, injecting or not injecting trillions of dollars directly into the hands of consumers and businesses, is a relevant variable.
Focus on Good Companies
While I do incorporate macro factors into my portfolio, the specific election outcome isn’t currently factoring much into my process, especially since we don’t yet know the outcome. I’ll re-assess the situation based on sweep or gridlock scenarios when we get the results, and see how the market reacts.
High-quality companies at appropriate valuations have plenty of resiliency against political outcomes, especially if they are diversified among a few different sectors. Diversifying into global equities further reduces political/jurisdictional risk. So, my emphasis comes down heavily to analyzing fundamentals, and balancing out risks rather than putting them all in one basket.
For example, I’d be somewhat uneasy about Apple (AAPL) at current prices:
Chart Source: F.A.S.T. Graph
And I’m not super-thrilled about Cadence Design Systems’ (CDNS) 3-5 year forward return prospects:
Chart Source: F.A.S.T. Graph
However, I’d be fine with Amgen’s (AMGN) risk/reward situation:
Chart Source: F.A.S.T. Graph
And fine with Enterprise Products Partners (EPD), considering both their headwinds as well as their beaten-down valuation:
Chart Source: F.A.S.T. Graph
Any one of those companies could surprise to the upside or downside in the years ahead. I’m not necessarily saying the second two will outperform the first two.
However, it’s about having a process to slant the long-term odds in your favor by buying quality companies at reasonable prices, knowing what you own, diversifying into enough sectors to avoid a catastrophic tail risk, and ensuring you don’t sabotage your returns by repeatedly selling low and buying high based on emotion.