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What Happens to the Stock Market During Elections in the US?

September 28, 2020 15:12 UTC

The year 2020 has thrust many unexpected and novel events upon us. However, on the 3rd of November, a very familiar event is scheduled to take place; the US presidential election, when the population of the United States will cast their votes on who will run the country with the world's largest economy for the next four years.

One of the many places where the impact of this event will be felt is the equities market. In this article, we will explore what happens in the stock market during elections and how this may affect your trading and investments. We will also look closely at the effect so far in this election year and what has happened in previous election years.

Stock Market During Elections in the US

Why and How Do Presidential Elections Affect the Stock Market?

During an election year, it is not known who will be leading the United States for the following term. Whoever wins the election will be able to influence the country's economy for the following four years through their policies. The fact that nobody knows whose policies will be adopted going forward, causes uncertainty surrounding the future political and economic direction of the country, this uncertainty inevitably filters through to the stock market.

The classic pattern one would expect to see in the stock market during elections is increased volatility and a tendency to go "sideways" in the months before the election, followed by a relief rally once the result becomes more obvious.

Increased Volatility

The stock markets can be unpredictable at times, however, their reaction to uncertainty is not. In uncertain times, seasoned investors shy away from the market, preferring instead to put their money into low risk investments or so called safe haven assets, such as gold.

Below is a chart of gold prices, which shows an increase in price in the run up to the 2016 US presidential election.

Gold Daily Chart MetaTrader 5Depicted: Admiral Markets MetaTrader 5 - Gold Daily Chart. Date Range: 19 May 2015 - 22 February 2017. Captured: 21 September 2020. Past performance is not necessarily an indication of future performance.

Investors who do not initially abandon the stock market during elections may act with increasing caution in the lead up to the event. Any hint from the press that their investments could be negatively affected going forward may cause them to quickly exit or adjust their positions. This can cause increased volatility and even drops in prices.

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Presidential Elections and the Volatility Index

The CBOE Volatility Index (VIX) is a measure of expected volatility in the stock market. Its figures are based on the S&P 500 index options.

Below is a table with a month by month breakdown of the average daily closing price of the VIX from the years 2010 - 2019. The columns are split into the average of the non-election years in this time frame and the average index figures from election years 2012 and 2016.


Non-Election Years:

2012:

2016:

January

15.823

20.228

23.718

February

16.83

18.421

22.517

March

15.866

16.167

15.849

April

14.968

17.823

14.3

May

16.1

21.002

14.853

June

16.577

21.131

17.775

July

15.242

17.562

13.159

August

18.845

15.69

12.4

September

18.98

15.285

14.22

October

18.427

16.276

14.585

November

17.235

16.702

15.236

December

17.47

17.345

12.472

Source: Monthly Average of Daily Closing Prices of CBOE Volatility Index (VIX). Date Range: 2010 - 2019.

An index score of below 12 implies that there is low volatility in the market, whilst above 20 signifies high volatility. Anything within the range of 12 - 20 is considered normal.

We can see from the above figures that during the 2012 and 2016 election years, there were several months in the run up to the election which had a considerably higher VIX score than the average of the non-election years. In fact, in the first seven months of both of these years, ten out of fourteen of them had higher VIX figures than the non-election average.

Bear in mind that the VIX is calculated in real-time over the whole trading day and that the above figures are all monthly averages. This will be masking the full extent of the intra-day volatility.

But what does this increased stock market volatility mean for traders and investors?

What Happens When Volatility Increases?

Volatility is a means of measuring price variability. High volatility implies a market has frequent fluctuations in price, whereas a non-volatile market will have more moderate and less frequent price fluctuations.

The thought of prices bouncing up and down may seem like a scary and risky prospect for some investors. However, although there is certainly an increased risk in trading markets with a high level of volatility, this can also be used to a trader's advantage.

The reality is that a 'choppy' market actually presents the savvy trader with a wide range of opportunities to turn a profit.

How Can Traders Benefit from Volatility?

For those who favour a short term approach to their trading, such as swing traders and day traders, volatility is absolutely essential to their trading strategies. These types of traders take advantage of both rising and falling prices.

Other, perhaps more traditional, traders lean towards longer term money making strategies. These strategies include buying shares in a company and holding them for a longer period of time in the hope of making a steady profit from the future growth and success of the company in question.

These types of traders may shy away from purchasing stocks with particularly high volatility, due to the increased risk, however, they can still benefit from volatility in the market. Price fluctuations can allow investors to take advantage of lower prices to purchase stock which they expect to rise again in the future.

Trading the Volatility with CFDs

People who trade using Contracts For Difference (CFDs) are able to profit from both rising and falling prices in the stock market, which is ideal for trading volatility. CFDs also allow traders to trade using leverage.

With Admiral Markets, you can trade CFDs on over 3,000 stocks, as well as numerous other financial markets. Click the banner below to open an account to today!

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The Importance of Risk Management

We spoke in the last section about how volatility can present a trader with profit making opportunities. However, it is important to note that increased volatility also increases the risks associated with trading. That is why it is very important to practice good risk management in your trading.

Risk management is all about identifying the risks involved with trading and taking measures to limit your exposure to them. Good risk management is essential and is often the difference between a successful trader and an unsuccessful one.

We also mentioned earlier that traders who use CFDs can benefit from leverage. It is important to note that leverage can be a double edged sword. Whilst the use of leverage can magnify your potential profits, it has the same potential to magnify your losses. This is why it must be used with caution.

How to Use Risk Management Tools in MetaTrader 5

The two most useful and important tools in MetaTrader to help with risk management are the stop loss and take profit.

Both tools protect your trades from unexpected market movements by allowing you to set a predefined price at which to automatically close your trade.

As the name suggests, the "stop loss" is intended to minimise any losses if the market moves against you.

The, equally aptly named, "take profit" allows you to secure your desired amount of profit before the market potentially moves against you.

You have the opportunity to set your desired stop loss and take profit levels at the same time as opening your trade. Clicking the "New Order" button to open a position presents the below dialogue box, the highlighted sections indicate where to set your stop loss and take profit.

Opening a Trade on MetaTrader 5

Depicted: Admiral Markets MetaTrader 5 - New Order

Once you have placed your trade, with desired stop loss and take profit levels, lines will appear on the price chart of your chosen asset indicating your predetermined exit points.

SP500 H4 Chart with Take Profit and Stop LossDepicted: Admiral Markets MetaTrader 5 - [SP500] H4 Chart. Date Range: 29 July 2020 - 21 September 2020. Captured: 21 September 2020. Past performance is not necessarily an indication of future performance.

Whilst these are very helpful tools we recommend you incorporate into your trading, it is important to note that neither a stop loss nor a take profit are not an absolute guarantee. There are occasions when the market moves so erratically that it creates price gaps and the tools are not able to close the trade at the programmed level. In this circumstance, the stop loss, or take profit, would instead be executed the next time the price reached the desired level. This scenario is known as slippage.

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How Does the Stock Market Perform in Election Years

We have spoken of the increased level of volatility in the stock market during elections in the US. However, volatility only tells us the level of price variation and does not indicate how well the stock market is actually performing.

So, how does the stock market actually perform during election years?

There have been 23 presidential elections since the inception of the index now known as the S&P 500 in 1926, although until 1957 there were only 90 stocks listed in the index. According to data from the Dimensional's Matrix Book 2019, out of these 23 election years, 19 have yielded a positive annual return on the index.

How Does the Stock Market Perform in the Months Preceding an Election?

But what happens in the months immediately preceding the election? The table below shows the percentage difference in price on the S&P 500, the Dow Jones Industrial Average (DJIA) and the NASDAQ Composite from the close of April until the close of October in election years since 1992.


S&P 500

DJIA

NASDAQ

1992

0.90%

-3.95%

4.58%

1996

7.81%

8.27%

2.60%

2000

-1.59%

2.21%

-12.72%

2004

2.07%

-1.94%

2.86%

2008

-30.08%

-27.26%

-28.67%

2012

1.02%

-0.89%

-2.27%

2016

2.95%

2.07%

8.66%

Average Excluding 2008

2.19%

0.96%

0.62%

Source: Composed by the author using historical data from the S&P 500, the Dow Jones Industrial Average and NASDAQ Composite.

If we exclude 2008 from the data set, we can see that all three indices average a positive return in the six months prior to elections since 1992.

Generally speaking, the S&P 500 has outperformed its rivals in the data set examined, recording fewer periods of negative growth. The DJIA, on the other hand, has recorded negative growth in four out of the seven six-month periods examined.

SP500 Weekly Chart MetaTrader 5Depicted: Admiral Markets MetaTrader 5 - [SP500] Weekly Chart. Date Range: 25 November 2011 - 21 September 2020. Captured: 21 September 2020. Past performance is not necessarily an indication of future performance.

What Has Happened to the Stock Market During This Election Year?

As noted at the start of the article, the year 2020 has seen many unexpected events which have had an impact on economies all over the world. The stock market has not escaped unscathed.

Therefore, it is likely that data from this year has been influenced more by events other than the US presidential election. However, the presidential elections would have no doubt had an impact as well.

The table below shows the monthly average of the VIX so far this year, as well as the monthly growth rates of the three stock indices we examined in the previous section.


VIX

S&P 500

NASDAQ

DJIA

January

13.94

-0.16%

1.99%

-0.99%

February

19.63

-8.41%

-6.38%

-10.07%

March

57.74

-12.51%

-10.12%

-13.74%

April

41.45

12.68%

15.45%

11.08%

May

30.90

4.53%

6.75%

4.26%

June

31.12

1.84%

5.99%

1.69%

July

26.84

5.51%

6.83%

2.38%

August

22.89

7.01%

9.59%

7.57%

Source: Composed by the author using historical data from the CBOE Volatility Index, the S&P 500, the Dow Jones Industrial Average and NASDAQ Composite.

Earlier, we noted that the normal parameters for a result in the VIX index is between 12 and 20. In the above table, we can see that this year has seen a remarkably high level of volatility in the market.

Looking at the monthly growth across the three stock indices, we can see that a bad start to the year culminated with heavy losses in March. However, since then, the markets have rallied incredibly, with high levels of growth in the following months.

In fact, between the months of April and August, the S&P 500 recorded its strongest 5-month run since 1938.

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Do These Results Provide Any Indication on the Result of the Upcoming Elections?

According to brokerage firm BTIG, since 1928, close to 90% of candidates representing the party in office prior to the election have won when the S&P 500 has returned positive results in the three months prior to the election.

August started this three month period with the S&P 500's best August returns since 1986. The omens, therefore, may appear good so far for the incumbent president. However, we should note that at the time of writing, 21 September, the S&P 500 is currently down 5.17% since the end of August.

How Could the Markets React to the Different Potential Outcomes?

In this election, there is probably more policy divergence than usual between the two candidates and also a more polarised electorate. There are fresh memories of Trump defying the polls and predictions to win four years ago. There is also speculation about the possibility of Trump not accepting the outcome if he were to lose.

For these reasons, we can expect more volatility than in "normal" elections, between now and the results being accepted by one side or the other.

Who Will Benefit from a Trump Victory?

Traditionally, Wall Street responds well to Republican victories. However, Trump's administration has brought a lot of unpredictability to policy-making, for example, suddenly announcing sanctions, tariffs or trade bans via Twitter with little prior discussion.

There are various stocks that are likely to react more positively to a Trump win – energy companies like ExxonMobil, and defence stocks like Lockheed Martin, for example.

Another group has done well under Trump - media companies. His presidency has driven a thirst for news that has seen the stock of companies like New York Times surge over the last 4 years.

Many believe that another Trump term would result in a weaker dollar and that this, in turn, would benefit smaller US exporters, who would suddenly look more competitive abroad.

Who Will Benefit from a Biden Victory?

The shares of companies that trade internationally, particularly those that trade heavily with China, are likely to react with relief to a comfortable Biden victory.

There will be winners and losers under a victory for either candidate. By far, the worst outcome would be one where the election results are contested by the loser - particularly if this happens to be the sitting president. Expect large falls and high volatility under this scenario.

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