Do US elections matter for stock returns?

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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.

However, for equity fund 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?

Judging by the time the financial media spends on the US presidential election, the answer to that last question must surely be a lot. At the time of writing, 20 per cent of Bloomberg’s top US news articles concern the vote. Most assume the outcome will have at least some impact on the economy’s direction and investment returns.

This paper will examine the evidence and explain why a selective stock-picking manager can thrive, whatever the political weather.

Reviewing returns

At first glance, there’s little to get excited about in the return numbers. The average annual price return for the S&P 500 going back six decades is about 8 per cent. In the year after a presidential election, the number is… just under 9 per cent. In the year prior, it’s about 8 per cent. There is significant volatility year by year, but nothing to suggest these years stand out from any other.

Even volatility isn’t significantly different from the norm in these years: the average standard deviation¹ from the annual price return is about 15 per cent, with the number before an election 16 per cent (ie a little more), and after 13.5 per cent (ie a little less).

Perhaps these figures mask something important. Like a man with his head in an oven and feet in a freezer, averages can give a meaningless assessment.

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 it:

• The average annual price return during a Republican presidency is about 5 per cent. During a Democratic presidency, it’s 11 per cent.
• In the year after a Republican victory, the average price return is 3 per cent. After a Democratic win, it’s 15 per cent.

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 per cent market drop over the year following the result. In the 12 months after Joe Biden’s win, the market surged 38 per cent in a trading environment distorted by the lifting of Covid lockdowns.

Challenging assumptions

There seems to be little that can be drawn from this analysis.

That makes sense if we examine what really drives markets – and a bottom-up, stock picker’s portfolios – over the long run. The argument above implicitly implies it is the economy, 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’s economy grew more than any other country. However, as a Credit Suisse study illustrates, that didn’t translate into the best stock market returns:

• The US market returned about an average of 6.5 per cent a year over the period.
• However, South Africa’s stock market beat it, achieving a 7.2 per cent 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 per cent. However, over this timespan, it’s trounced by the Dow Jones Denmark, which returned just over 1,500 per cent 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. Firstly, much of a stock market’s return is driven by overseas revenues. For the S&P 500 today, international sales are approaching 40 per cent of the total. Secondly, 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.

Long-term perspective

Perhaps the sharpest way to demonstrate this is to take hotly contested issues of the past, contrast them with important technological advances and company launches, and ask what mattered more for long-term stock returns.

Picking a few:

• In 1948, Americans debated how to navigate the emerging Cold War and domestic economic policy. A year earlier, Bell Labs invented the transistor, setting into motion the chain of innovation that led to silicon chips.
• In 1952, the Korean War was front of mind. At the same time, IBM introduced the IBM 701, its first scientific computer.
• In 1968 and 1972, controversy over the Vietnam War raged. Intel was founded in the earlier year, and Atari released Pong in the latter, launching the video game industry.

It’s easy to do this for almost every election. 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?

In a generation’s time, writers will surely make the same assessment of today.

Debate is as fierce – perhaps fiercer – than it has ever been, and it would be easy to equate the noise and fury with import for stock returns. But when you compare it to the progress companies are making at a fundamental level, you reach a different conclusion.

Health and automation game-changers

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 long-term Baillie Gifford holding Novo Nordisk, which derives most of its revenue from the US, such decisions won’t meaningfully impact long-run stock returns.

What will matter is the revolutionary potential of the company’s new anti-obesity drugs. If Novo Nordisk continues improving efficacy, decreasing side effects and developing exciting therapies, then its future will be bright.

Baillie Gifford first invested in the firm nearly 24 years ago. Our analysis has focused on its innovative culture, its impressive collection of accumulated diabetes and obesity knowledge stretching back over 100 years, and the enormous size of this market. These considerations remain relevant, not who sits in the White House.

Fists may be shaken during the ever-polarised immigration debate. The supply and cost of labour are relevant considerations for many businesses. However, they should be seen in the context of companies fundamentally changing how we work.

Aurora, for example, is pioneering autonomous trucks. Adapted vehicles can drive through the night without risk of 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, and defence companies are reliant on government contracts.

Infrastructure also counts politics as its ultimate source of demand. But here, investors with an eye for long-term trends and the dynamics that power real change can profit without overexposing themselves to risks caused by shifts in the political wind.

Policy often determines the exact dollar amounts and timings regarding infrastructure investments. However, that policy is often the product of unignorable long-term trends.

The US Society of Civil Engineers gives American infrastructure a C- rating. Shortcomings are apparent to citizens whenever they’re stuck in traffic or without power for days after a storm. And that’s before the impact of a changing climate.

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.

The cherry on top is a stock market currently unwilling to account for much growth, resulting in a low valuation. The potential for a demand surprise coupled with supply constraints creates the potential for strong returns. Politics may – should – be helpful, but we don’t need it to make money for our clients.

Our advantage 

We have no special insight into who will win in November or any other election. But we do regarding revolutionary medicine, autonomous trucks and telegraph poles.

Indeed, it is invariably 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 may pursue the path towards potentially sourcing outsized returns, while leaving the task of political crystal ball gazing to others.

¹ A measure of the volatility of absolute returns. It is a measure of the dispersion of a set of absolute returns from its mean.

Important information and risk factors

The Funds are distributed by Baillie Gifford Funds Services LLC. Baillie Gifford Funds Services LLC is registered as a broker-dealer with the SEC, a member of FINRA and is an affiliate of Baillie Gifford Overseas Limited. All information is sourced from Baillie Gifford & Co unless otherwise stated.

As with all mutual funds, the value of an investment in the Fund could decline, so you could lose money. International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty and greater volatility. These risks are even greater when investing in emerging markets. Security prices in emerging markets can be significantly more volatile than in the more developed nations of the world, reflecting the greater uncertainties of investing in less established markets and economies. Currency risk includes the risk that the foreign currencies in which a Fund’s investments are traded, in which a Fund receives income, or in which a Fund has taken a position, will decline in value relative to the U.S. dollar. Hedging against a decline in the value of currency does not eliminate fluctuations in the prices of portfolio securities or prevent losses if the prices of such securities decline. In addition, hedging a foreign currency can have a negative effect on performance if the U.S. dollar declines in value relative to that currency, or if the currency hedging is otherwise ineffective.

For more information about these and other risks of an investment in the Funds, see “Principal Investment Risks” and “Additional Investment Strategies” in the prospectus. There can be no assurance that the Funds will achieve their investment objectives.

Data as of 30 September 2024

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