Close Presidential Elections Are Usually Followed By Big Stock Market Swings

Post-Election Apprehension

Our view remains that a closely divided and hard-fought election will be followed by more fighting in a divisive and bitter lame duck session in Congress, resulting in higher volatility and a potential pullback for the stock market.

As the race continues to tighten, the market shed -3.3% during last seven trading days (October 18–26).

In general, the post-election environment has not been a bad one for stocks. The S&P 500 has posted gains two-thirds of the time from the election through year-end.

This is similar to the performance of the markets during any other roughly two-month period. However, digging deeper into the markets’ performance during elections that have similarities to the current one may shed insight into how the markets may perform in the coming months.

While the S&P 500 has posted gains, on average, between the election and the end of the year, the tighter races saw bigger moves and wider swings, as you can see in Figure 1. Nearly half of the time (four of the past nine elections), the ultimate loser of the election was ahead in the Gallup polls as of late October, highlighting a very close race. An exception can be seen in 2008. While 2008 was still relatively close, it was not as tight as the current race.

Volatility was tremendous, as the financial crisis unfolded and stocks plunged as the United States fell into a deep recession—all unrelated to the election. The average percentage post-election change in the stock market (in either direction) for the close races in 1976, 1980 (though the election turned out to be an upset win for Reagan), 2000, and 2004 was 6.4%. This was triple the 2.2% average change in those elections that were not as close, when excluding 2008. The swing from high to low in the S&P 500 was twice as wide following the close elections than the others, excluding 2008. When including 2008, the tight races still had a much larger average move, but only slightly greater average swings.

Figure 1: Close Races Lead to Volatility

The Closer to Election, the Loser was Ahead in Gallup Poll, and the Bigger the Swings

Source: LPL Financial, Bloomberg data, Gallup 10/29/12 

Drilling further down to look at those presidential election years that had lame duck sessions in Congress also may offer insight, since Congress has a big budget challenge ahead in this year’s lame duck session. These years have not been good for stocks. Excluding 2008 from the four lame duck legislative sessions during presidential election years since 1948, the S&P 500 was down in each of the lame duck sessions that took place in 1980, 2000, and 2004. The losses were modest ranging from less than 1% to nearly 4%.

Importantly, these market losses took place despite important legislative accomplishments in those lame duck sessions. The Congressional Research Service in their 2009 publication entitled Lame Duck Sessions of Congress 1935-2008 recount the accomplishments during these sessions:

• 1980 – During the lame duck session, from November 12 to December 16, 1980, Congress completed action on many of the issues that had been left unfinished in the regular session, including the following: a budget resolution and a budget reconciliation measure; five regular appropriations bills, although one was subsequently vetoed; and a second continuing resolution was approved to continue funding for other parts of the government. Non-budget-related actions included an Alaska lands bill and a "superfund" bill to help clean up chemical contamination, a measure extending general revenue sharing for three years, a measure that made disposal of low-level nuclear waste a state responsibility, changes to military pay and benefits, and authority for the president to call 100,000 military reservists to active duty without declaring a national emergency.

• 2000 – The House returned on November 13 and the Senate a day later; they faced a still-undecided presidential election yet faced substantial budget decisions. They approved a short-term continuing resolution and then agreed to a further recess until December 5. After reconvening on December 5, Congress agreed to a series of five short-term continuing resolutions, while final decisions on the remaining appropriations were being negotiated. During this sequence of events, the Senate recessed on December 11 after providing, by unanimous consent, that when the fourth in this series of continuing resolutions was received from the House, it would automatically be deemed passed in the Senate. Finally, on December 15, both chambers completed action on fiscal year 2001 appropriations measures by agreeing to the conference report on the omnibus appropriations bill. In addition, Congress also cleared the Presidential Threat Protection Act, the Striped Bass Conservation Act, and the Intelligence Authorization Act. It also sent President Clinton a bankruptcy reform measure, which the president subsequently pocket vetoed.

• 2004 – From November 13 through December 9, 2004, Congress reconvened with a need to increase the debt ceiling and address spending bills. Congress passed an increase to the debt limit, and an omnibus appropriations measure was passed that included caps on domestic discretionary spending as well as the elimination of many authorizing provisions. Congress also passed several other reauthorizations, including the Individuals with Disabilities Education Act, a moratorium on internet taxation, and authority for satellite television systems to carry network programming.

While again this year Congress has a full lame duck session agenda and the stakes are very high, we expect progress to be made mitigating the potentially recessionary impact of the budget bombshell of tax increases and spending cuts due to hit on January 1, known as the fiscal cliff. However, progress alone does not mean market gains are assured, as history attests. The negotiations themselves, coming on the heels of hard-fought election battles, can drive wide market swings and result in modest losses. A mildly defensive posture may benefit investors heading into the final months of the year as markets may provide attractive buying opportunities.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

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