Everyone is aware of the importance of the U.S. elections and we take it for granted that, like many other things, financial markets will end up being affected in some way. But have you ever wondered if there is any seasonality throughout those elections that we can take advantage of when making investment decisions? Let’s find out!
The following charts show the historical evolution of the Standard and Poor’s 500 (S&P 500) and the Cboe Volatility Index (VIX) in which we are all able to identify some relevant events such as the Covid-19 pandemic or the economic crisis of the years 2000 and 2008. All these events had a great impact on the economy and shared some characteristics such as increased volatility and a sharp fall in the value of stocks.
It is true that the events discussed above are totally unexpected. However, there are many other pre-planned events that, even if their impact on the markets is not so easy to perceive, that does not mean that they do not have it. In fact, in many cases after analyzing them in detail we are able to obtain very valuable information to make better future investment decisions when similar events are expected.
These types of events are part of the many available alternative data that is becoming so popular among investors because of the amount of additional information to the traditional financial data that they provide. For the moment, we will focus on the United States (U.S.) elections as an example of such expected events, although there are many more of them, including the Fed’s announcements, which were previously discussed in this post.
U.S. presidential elections
Early November every four years, U.S. citizens are set to vote for their favorite candidate for president and, as politics and economics are closely linked, it is reasonable to think that financial markets may be affected, especially the U.S. market, which is the one we will look at.
The next table reminds us the results of the last U.S. presidential elections by showing us the date they were held, as well as the names and political party to which the winners belonged. We could go even further back, but I think this will be enough to show some interesting results.
The idea is to analyze the impact of the U.S. presidential elections on the S&P 500 and the VIX both on the election day itself and in the weeks leading up to and following the election. In particular, the following charts show the evolution of the performance of the S&P 500 and the VIX from the 30 business days prior to the election to the 30 business days after the election. It is certain that the 30 business days (about a month and a half) have been chosen somewhat randomly, although it seems to be a reasonable value to be able to observe if there is any pattern in the behavior of financial markets among different elections.
Maybe you have noticed that the presidential elections of 2000 and 2008 are missing in the previous graphs, but they have been omitted because I believe that those elections should be studied separately as they took place in very special circumstances, which led the market to behave in a very different way compared to other presidential election periods. Therefore, focusing on the rest of the elections which were held in a relatively comparable context, we notice how, in general terms, during the previous weeks the market is rather stabilized and, as the presidential elections approach, volatility increases, until they are held and a phase begins in which volatility decreases and the value of the shares rises.
The following table summarizes the results obtained for each of the three periods analyzed in each of the U.S. presidential elections, including those of 2000 and 2008, as well as the average returns in each of these periods taking into account all of them and excluding those of the years 2000 and 2008.
First of all, it seems clear that market behavior during U.S. presidential elections held in times of crisis such as those of 2000 and 2008 is totally different, so they need be studied separately. It should be noted that those of 2020 also took place in very particular circumstances, but the behavior in this case is similar to the others. Then, ignoring those two elections, the table corroborates the conclusions commented above. This makes sense because, in general, during any major uncertain event, such as a presidential election, stock market volatility tends to increase, and after the event it usually stabilizes again.
Therefore, it seems that under normal conditions, the weeks leading up to the U.S. presidential election are ideal for buyers of volatility, while the weeks after are ideal for sellers of volatility. In addition, it might be reasonable to look for other investment alternatives to the S&P 500 during the month prior to the election when it is usually flat and recover it afterwards when the index is usually in an uptrend.
U.S. midterm elections
Anyway, you may not have to wait until the next U.S. presidential election for this post to be useful because in November this year midterm elections are held in the U.S., which are general elections that take place near the middle of a president’s four-year term and in which the House of Representatives and part of the Senate are elected. Surprisingly, as the following graph shows, years in which midterm elections are held are associated with much worse S&P 500 results when compared to the rest of the years.
Whatever the reason for this difference is, knowing that in November this year midterm elections are held, do you think we will stick to the path shown by historical data and have a bearish September followed by a recovery in winter? We will see!
This post has shown how to take advantage of the trends related to the U.S. electoral cycle, which is just one of the many examples of pre-planned events that take place from time to time. I encourage you to find out more about this and other examples, as if we are able to understand the movements these expected events cause in the financial markets, we will have in our hands very valuable information to include in the development of our investment strategies and, thus, improve the results we obtain from them.
Thanks for reading!