Note: Fisher Investments UK’s political commentary is intentionally nonpartisan. We favour no political party nor any politician and assess political developments solely for their potential economic and market impact.
Whenever an election approaches, no matter the country, Fisher Investments UK sees an abundance of commentary arguing the results will be make-or-break for markets. Most of it focuses on the leading candidates’ personalities and traditional biases painting some parties as inherently good for markets and others as bad. We saw it with last year’s US election, and now we have seen it in the financial press’s coverage of this year’s European elections. In our view, however, it all misses a key point and risks leading investors astray as a result: Markets care about policies, not personalities, and the degree to which any changes are better or worse than generally expected.
In our view, US equity market returns’ long history best shows this, as we can assess returns in the election and inaugural years of 24 presidential cycles. According to our research, the election year is typically when markets register investors’ hopes or fears about the next president, whilst the inaugural year is when reality usually takes hold. In our experience, about two-thirds of US investors lean Republican and fear Democratic presidents will enact policies that impede equity markets. Accordingly, in election years when a Republican wins, we think high hopes propel average 15.2% annual returns.[i] But in years when a Democrat wins, we think fears knock average returns down to just 7.4%.[ii] (This analysis excludes 2020, as having only Joe Biden’s election year and not his inaugural year would result in mismatched data sets.)
In the inaugural year, though, we think reality emerges: All presidents, regardless of party, are just politicians. Not only do they generally have to negotiate and water down flagship campaign pledges in order to get legislation passed, but many big pledges never even become legislation. We think this is why inaugural-year returns average just 2.6% under Republican presidents—in our view, it is a manifestation of investors’ disappointment.[iii] But returns in Democratic presidents’ inaugural years improve to 16.2%, and we think relief and falling uncertainty are behind these high average returns.[iv] Over the full two-year stretch, though, there doesn’t appear to be a huge difference between the parties: Returns average 18.0% when a Republican wins and 23.4% when a Democrat wins.[v] Whilst it might be tempting to read into this, we don’t think that is useful, as politics is just one market driver. The vast majority of economic activity in the US and developed Europe emerges from the private sector, making economic drivers crucial.[vi]
Still, we think the presidential return history hints at a key point: Political biases often don’t match reality. Our research has found that, worldwide, no political party is inherently good or bad for markets. None have demonstrated that they have a monopoly on policies that help or hurt publicly traded companies and the broader economy. In the US, for example, some of the legislation we consider most unhelpful for equity markets was bipartisan—for example, the Tariff Act of 1930, which vastly increased tariffs and contributed to deep declines in global trade, or 2002’s Sarbanes-Oxley Act, which vastly increased restrictions and regulations on publicly traded companies. Republicans and Democrats alike have added and removed regulations and cut and raised taxes. Our analysis of British history yields similar findings, and we have observed British shares having periods of boom and bust under both Labour and Conservative governments.[vii]
Therefore, instead of basing analysis around the political party (or parties) in charge, we think it is most helpful to strip out biases and think about policies. We think markets generally dislike rising uncertainty and love falling uncertainty. On the political front, we think that means equities get relatively more agitated when legislative uncertainty is high. That makes an active government, regardless of ideological creed, the primary political risk for equity markets, in our view. Relatedly, we think the most bullish backdrop is political gridlock, which keeps legislative risk and uncertainty low.
In our experience, this is difficult for many investors to fathom because political biases colour thinking. Many partisan investors would logically want their party to accomplish the agenda they voted for. Politicians generally sell their proposed policies to voters by touting the potential winners. But in our experience, all legislation creates losers as well as winners, bringing psychological forces into play. Behavioural scientists have demonstrated that when confronted with the prospect of gains and losses, the losing parties feel the pain of potential loss significantly more than the winning parties feel the joy of potential gain.[viii] Hence, if a legislature is active, we think the associated uncertainty can weigh on sentiment.
But that doesn’t render returns negative automatically, as equity market history demonstrates. If investors broadly fear disruptive legislation and whatever passes is watered down relative to those expectations, we think that can be a good-enough surprise to help markets. We saw this in America in 2010, when US President Barack Obama passed widely feared healthcare and financial-reform bills. Both were large—but not as sweeping and radical as many politicians initially proposed. If financial commentary at the time is any indication, investors appeared broadly relieved by this, which we think contributed to positive US equity returns that year.[ix]
In Fisher Investments UK’s view, gridlock also explains why several European nations enjoyed positive returns even as populist parties entered government in recent years. That includes Italy, where the coalition formed by the anti-establishment Five Star Movement and nationalist League in 2017 sparked warnings from financial commentators we follow worldwide that the country would get a radical economic makeover and leave the eurozone. Instead, the coalition partners seemingly spent two years bickering and getting nothing done, and we think Italian shares benefitted from the falling uncertainty.[x]
In Spain, similar warnings perked throughout financial commentary when the leftist populist Podemos party entered a coalition with the centre-left Social Democrats in January 2020. But there, too, very little has happened. The government only recently passed its first budget, and it was a watered-down version of initial proposals. Income tax rises were much smaller than originally outlined, and the government scrapped plans for a minimum corporate tax. Looking ahead, as the pandemic fades, we think it should clear the way for Spanish equities to enjoy the tailwind of falling uncertainty as investors realise the coalition’s weakness.
Now, we think the above analysis applies most to developed nations. In Emerging Markets, where there is frequently more state intervention in the economy and capital markets are less mature, Fisher Investments UK’s analysis suggests active, reform-minded governments can be positive factors for markets—and gridlock can prove to be a disappointment. Therefore, we think analysing political drivers in that category requires much more nuance. But in developed Asia, Europe and North America, we think gridlock generally preserves a status quo that markets have dealt with for decades, giving investors one less thing to worry about.
Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
[i] Source: Global Financial Data, as of 04/10/2020. S&P 500 total returns, 31/12/1925–31/12/2019. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.
[vi] Source: FactSet, as of 10/02/2021. Statement based on public and private contributions to gross domestic product, or GDP. GDP is a government-produced estimate of economic output.
[vii] Source: FactSet, as of 10/02/2021. Statement based on FTSE 100 returns. Presented in British pounds. Currency fluctuations between the pound and dollar may result in higher or lower investment returns.
[viii] “Prospect Theory: An Analysis of Decision Under Risk,” Daniel Kahneman and Amos Tversky, Econometrica, Vol. 47, No. 2 (March 1979).
[ix] Source: FactSet, as of 10/02/2021. Statement based on S&P 500 total return, 31/12/2009–31/12/2010. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.
[x] Source: FactSet, as of 10/02/2021. Statement based on MSCI Italy Index returns with net dividends.