How An Election Really Influences Markets

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One of the oldest axioms about stocks is that markets don’t like uncertainty.

This Presidential election cycle has been full of major surprises to say the least.  However, when you look back at how stocks have responded during Presidential election years the results have been positive more often than not.  Looking even deeper, more than half of the time the 4th quarter of the election year has seen stocks hit their highest price for that year [See Results Here]. So it is just as likely that after this election is over that stocks could move higher rather than lower by the end of the year.

Surprises Are Not Uncommon

The recent Brexit vote is an example of how difficult it is to try to “time the market” by going to an extreme position (i.e. all cash) in a portfolio strategy.  Two trading days after the UK voted to exit the Eurozone, the S&P 500 had fallen over 5% and the broad foreign markets were down close to 10%.  Within 30 days the S&P 500 had recovered all of its losses and had actually moved 3% higher than the pre-Brexit level.

We aren’t discounting the possibility that stocks could sell off after the Presidential election and continue to move lower.  After all, this bull market is the second longest since the Great Depression and U.S. valuations have been at elevated levels for some time.  But, your strategy should be guided by a disciplined approach based on your specific situation. One of the toughest parts of investing is to stick with your process when sentiment tides are going the opposite direction. This is because investment themes can take years and even decades to play out, and they generally do it slowly. So one of the most effective actions you can take is to limit emotional influence from the noise of our hypnotizing 24-hour news cycle. Easier said than done of course.

Prepare Beforehand

We design portfolio strategies based on the level of risk that is appropriate for a client’s unique situation.  We look at the level of cash flows that the client projects to have over a full stock market cycle and allocate a sufficient level of cash and bonds to their portfolio.  This allows for cash flow needs to be paid out of fixed income assets rather than stocks during market selloffs as well as “dry powder” for when stock prices become attractive enough to increase exposure.

As long as you are using an appropriate, diversified allocation for your portfolio, then you should not need to make major adjustments based on what is happening in the stock market or political environment in the short-run.  If you feel compelled to, revisit your financial plan.  What are your income sources and planned expenditures over the next 5-10 years?  How will these be met?

Having a plan in place for when volatility and losses inevitably occur is critical.  It’s also the best defense on the emotional battlefield we all face when investing.

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