Outline for the Election Playbook: Part 2

• High single stock risk and lower market breadth, which could be seen during election years, underscores the importance of broad diversification.
• Tighter races have tended to lead to higher volatility. Investors concerned about volatility this year may have options, including minimum volatility exposures, buffered funds, and sectors that are historically less tethered to election outcomes.
• ETFs are diversified funds that can be appropriate for both core holdings and tactical trading around specific events.

Political outcomes and market outcomes can be intertwined, but it’s difficult to prove whether one causes the other.

In fact, markets have tended to be agnostic about political leadership in the long term. As detailed in part 1 of our election playbook, investors who held the course as political winds changed earned nearly twice as much in the last decade vs those who plumped purely for their party.

We take a more granular look at the market’s performance during election cycles here in part 2, focusing on:

• The performance of markets before and after presidential elections.
• How markets have responded to contested races, and which sectors have stood out if election-related volatility was elevated.

We examined the performance of markets before and after presidential elections and compared it to the performance of markets in non-election years. On average, in election years that end with no change in political party, the performance of the market has been statistically similar to non-election years.

However, in years with elections that end in a party switch, the market has (on average) underperformed non-election years.¹

On average, U.S. markets have outperformed in the 12 months following a presidential election with no change in party, regardless of which party won or lost.² We believe, the outperformance likely does not stem from the continuity of political policy but rather likely a reflection that the factors that bolster market performance — macroeconomics, fiscal and monetary policies, corporate earnings, and investor sentiment — likely also helped convince the electorate to keep the same party in power. 

That said, we see evidence that some of the political uncertainty in elections has been associated with higher volatility in equity markets. Consistent with this idea of policy uncertainty, we found equity volatility has tracked slightly higher for the 90 days preceding presidential elections than in the 90 days following the election, with the heightened volatility even more pronounced in elections that ended with a party switch.³

We also analyzed the polling in each individual election in the sample period and found that the periods of rising equity volatility were contemporaneous with a tightening in the polling — tightly contested elections have been consistent with higher equity volatility.

Single stock risk has been elevated during election years, and market breadth has been lower; on average, the percentage of S&P 500 constituents that traded above their 200-day moving average has hovered in the upper 60s, but has dipped during election years before reversing back up to historical averages after November.⁴

When the number of outperformers narrows, the importance of diversification only grows. ETFs can provide a sensible way to mitigate risk though diversified funds, which can be appropriate for both core holdings and tactical trading around specific events.

Among sectors, financials, energy, and materials have been notable outperformers in the 12 months following a presidential election.⁵ We do not attribute these results to the election cycle itself, but rather to the fact that the key supports for a cyclical upturn were already in place for the periods in the sample when elections took place. Notably the sample contained a few unique factors that boosted the relative performance of these sectors, including the end of the global Financial Crisis in 2009 (Financials) and the end of the COVID lockdown in 2021 (Energy and Materials).

Conversely, both industrials and information technology sectors tended to be less sensitive to election outcomes, with their one month return pre-election mirroring their one month return post-election, dating back to 1992.⁶

Against this backdrop, we encourage investors to stay invested. Rather than moving into — or staying in — cash, investors may consider buffered strategies, which look to track the return of a broad market up to an approximate upside limit, while seeking to maximize the downside protection against potential price declines.

We also see opportunity in minimum volatility exposures which can add resilience to portfolios as markets digest potential policy pivots and volatility could track higher. Defensive sectors like utilities can also benefit portfolios. Investors interested in minimum volatility or utilities could consider the iShares MSCI USA Min Vol Factor ETF (USMV) or the iShares U.S. Utilities ETF (IDU).

We continue to lean into quality in equities: margin resilience and profitability remain important against a backdrop of heightened macro volatility. The BlackRock U.S. Equity Factor Rotation ETF (DYNF) along with the iShares MSCI USA Quality Factor ETF (QUAL) together can offer exposure to quality in your portfolio.

Stay nimble in fixed income. Rates have already moved significantly in anticipation of the Fed being more aggressive with rate cuts, starting with its September meeting.  With this in mind, we like the 3-7 year duration portion of the Treasury yield curve. Investors interested in treasuries with durations of 3 to 7 years, could explore the iShares 3-7 Year Treasure Bond ETF (IEI).