Here's How Presidents and Elections Affect the Stock Market

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Thursday marks the conclusion of the Republican National Convention, the first of two major party conventions that will see Donald Trump and Hillary Clinton accept their respective nominations. This election year has already been uniquely contested, and there's still several important months ahead of us.

With the media portraying an increasingly polarized country and a Supreme Court spot up for grabs, this year's election also promises to be very important. As nationwide polls continue to come in, it's obviously too early to call the race and it looks like we won't be sure of a winner until Election Day.

So what does this mean for investors? Well, for now, it means uncertainty. We know the market doesn't like uncertainty, but does the winner of the presidential race even matter for us? Today we're going to look at some trends and tendencies to determine what effect, if any, the president has on the stock market.

Historical Trends

Before we ask any sort of "Why?" question, it's easier to simply identify the facts. One clear trend involving presidents and share prices is that the stock market tends to have more favorable returns under Democratic presidents. Since 1900, the Dow Jones Industrial average has returned 7.0% annually under Democratic presidents, compared to 3.0% under Republican presidents.

When we break this down further, we also notice a trend between market performance and the year of a president's term. Far and away, the third year of one's presidency tends to be the best year for market returns, while the final year, or "lame duck year," tends to be the worst.

The sluggish performance associated with lame duck years probably has to do with the president's lack of political restraint. Since the lame duck doesn't have an election to win, they can be a bit more unpredictable. It's also important to remember that lame duck years are also election years, which indicates that elections can also signal rocky performance.

Fiscal vs. Economic Policy

We also need to take into consideration what powers the president has to actually affect the economy. Remember, there's no magic gas prices and stocks button in the Oval Office. The president is just one part of an intricate system of checks and balances, and it can be hard to recognize exactly what pieces of their ideology are actually doing something. On that note, let's define fiscal policy and monetary policy.

Fiscal policy is the use of government revenue collection to collect and distribute money in an effort to influence the economy. In other words, it's how the government adjusts spending levels and tax rates to make a specific impact on the economic activity in the country.

The president is able to have a significant impact on fiscal policy. In many elections, you'll see candidates running with specific fiscal policy plans, and once elected, the president can support legislation that defines that policy. Of course, the other key actor in the fiscal policy play is Congress, and any legislation has to go through both the executive and legislative branches.

On the other hand, monetary policy is set by a central bank; in the case of the United States, this is the Federal Reserve's job. The Fed sets interest rates to influence the amount of money that is available to spend in the economy.

Both fiscal and monetary policy affect how much money consumers have in their hands, which affects economic performance, which affects the stock market. Both of these tactics can send stocks up or down.

However, it is probably fair to say that the markets anticipate news from the Fed more. Especially this year, we have seen big reactions to the news that the Fed was delaying its interest rate hike schedule, which created a sense of uncertainty of the state of the economy.

We also have to note that not all presidents see a correlation between the health of the economy and positive stock returns. For example, Besides Nixon, Lyndon B. Johnson saw the worst post WWII market returns, yet gross domestic product was hitting new heights during his presidency. On the other hand, George H.W. Bush saw average market returns during a notably sluggish economy.

Case by Case Basis

Perhaps the biggest presidential effects on stocks are seen on a specific case-by-case basis. For example, we have seen a massive shakeup in the healthcare industry since the passing of the Affordable Care Act under President Obama. Just take a look a returns on stocks like UnitedHealth UNH , Humana HUM , Aetna AET , and Universal Health Services UHS since Obamacare passed in 2010.

Looking forward, we can start to identify the sectors that could move based on the major points of Clinton and Trump's platforms. For example, when Clinton tweeted about reigning in price gouging in the drug market last year, the major biotech ETF IBB fell nearly 4.5% in a day, and that was before Clinton was even close to locking up the nomination.

Clinton has also shown to be more hawkish on national security than President Obama, and her campaign has received the most donations from the aerospace and defense sector. Take a look at these defense stocks that could win big if Hillary Clinton becomes president .

In a surprising twist, Donald Trump's campaign took a left-leaning stance on big banks during the convention this week, officially adopting the stance that Glass-Steagall should be reinstated. You can check out a few big banks that could lose if Donald Trump wins .

Bottom Line

This election is an important one, and investors should always be keeping their eyes on something that could have even the tiniest effect on stocks. Although the past indicates that the market favors Democrats, it's much easier to identify specific sectors and stocks that would be affected by the platforms of the winner. A president simply does not have all of the power when it comes to the performance of the entire stock market.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks
Referenced Symbols: IBB , AET , HUM , UNH , UHS

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