Do elections matter? Of course they do. Elections can change all sorts of things: how we live, access to healthcare and education, the regulations businesses must abide by and how much money is in our pockets at the month’s end.
For equity managers, the critical questions are: what do elections mean for stock picking? Do they influence whether the market goes up or down? By how much?
However, evidence shows that a selective stock-picking manager can thrive, whatever the political climate.
Reviewing returns
The average annual price return for the S&P 500 going back six decades is about 8%. In the year after a presidential election, the number is… just under 9%. In the year prior, it’s about 8%. There is significant volatility year by year, but nothing suggests these years stand out from any other.
Even volatility isn’t significantly different from the norm in these years: the average standard deviation from the annual price return is about 15%, with the number before an election 16% (i.e. a little more), and after 13.5% (i.e. a little less).
Perhaps these averages mask something important.
What about Republicans versus Democrats? It may be tempting to assume low-tax, low-regulation Republicans are a stock market winner, but the data doesn’t show that.
The average annual price return during a Republican presidency is about 5%. During a Democratic presidency, it’s 11%.
In the year after a Republican victory, the average price return is 3%. After a Democratic win, it’s 15%.
However, these figures are distorted by big one-offs. George W Bush’s election coincided with the dotcom bubble’s burst, leading to a 22% market drop over the year following the result. In the 12 months after Joe Biden’s win, the market surged 38% in a trading environment distorted by the lifting of Covid lockdowns.
Challenging assumptions
The argument above implicitly implies it is the economy that drives markets, which in turn is driven by politics.
But the relationship between the strength of economic growth and market returns is shaky at best. Between 1900 and 2022, the US economy grew more than any other country. However, that didn’t translate into the best stock market returns.
The US market returned about an average of 6.5% a year over the period. However, South Africa’s stock market beat it, achieving a 7.2% return despite pedestrian economic growth. When translated into US dollars, the returns of the two countries are about the same. But on this common currency basis, Australia comes out on top.
If you switch the starting point to 1998, the S&P 500 has made an impressive gain, returning just shy of 500%. However, over this timespan, it’s trounced by the Dow Jones Denmark, which returned just over 1,500% in US dollar terms despite slower economic growth.
Of course, starting points matter when making such comparisons. This is a key point: one reason index returns deviate from economic performance is that the former depends on starting valuations, which are a proxy for investor sentiment about a country’s stock market prospects.
However, there are two further reasons. First, much of a stock market’s return is driven by overseas revenues. For the S&P 500 today, international sales are approaching 40% of the total. Second, the stock market mainly accounts for large public businesses, ignoring private and smaller companies, let alone government spending.
Therefore, even if we assume that presidents influence economies, they aren’t a decisive factor in driving markets. Which begs the question: what does matter?
The short answer is innovation and entrepreneurship. The stock market is, after all, merely a collection of companies. Furthermore, it tends to be driven by the outsized successes of a few big winners.
What is game-changing from a long-term perspective?
Perhaps the sharpest way to demonstrate this is to take hotly contested issues of the past and contrast them with important technological advances and company launches.
What mattered more in 1976, the fallout from Watergate or Apple’s founding? In 1996, was it the role and size of the federal government or Larry Page and Sergey Brin launching Google? Should investors have paid more attention to 2004’s immigration debate or wondered about Facebook’s potential?
Politicians may debate the appropriate level of taxation or regulation for already profitable businesses. This can affect discounted cash flows (which some investors use to determine an asset’s current value based on forecasts of how much money it will make in the future).
However, for a company such as Novo Nordisk, which derives most of its revenue from the US, it is its impressive collection of accumulated diabetes and obesity knowledge stretching back over 100 years, and the enormous size of this market, that matters most to long-run stock returns. Not who sits in the White House.
Another example is Aurora, a company pioneering autonomous trucks. Adapted vehicles can drive through the night without risk of driver exhaustion and in the most fuel-efficient manner. As this technology matures, the implications are profound for the efficiency and safety of our transport networks. Regulations may take time to catch up, but the long-term result is as inevitable as an Aurora vehicle reaching its destination.
Infrastructure outliers
Some sectors seem more susceptible to politics than others. Finance, for instance, is heavily regulated. Infrastructure also counts politics as its ultimate source of demand.
Policy often determines the exact dollar amounts and timings regarding infrastructure investments. However, that policy is often the product of long-term trends.
Part of the reason infrastructure investment is a broadly bipartisan issue today is because the effects of its deterioration are widespread. Things will change, no matter who’s in the Oval Office. Still, it pays to be selective and to look for companies with the best potential for outperformance.
Where does burgeoning, long-term demand meet other stock-specific attributes? One answer is Stella-Jones, a maker of telegraph poles, among other wooden products. Stella controls most of North America’s supply, making it vital to upgrading and maintaining power and telecommunication networks.
Even if demand for its poles moderated to only a sustainable replacement level, there would be a shortage. Moreover, supply can only expand slowly, so Stella-Jones can charge good prices.
A stock picker’s advantage
We have no special insight into who will win this week or in any other election. But we do regarding revolutionary medicine, autonomous trucks and telegraph poles.
Indeed, it is much easier to step back and ask: what’s really changing? Where are the fires of innovation and entrepreneurship burning the brightest?
The selective stock picker can follow that light to outsized returns and leave the political crystal ball gazing to others.
Michael Taylor is an investment manager at Baillie Gifford. The views expressed above should not be taken as investment advice.