How Presidential Elections Impact the Dow

2016 has been an outlier in terms of how the election has impacted the Dow

Bernie Schaeffer
Nov 7, 2016 at 8:24 AM
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The following is a reprint of the market commentary from the November 2016 edition of The Option Advisor, published on October 27. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- click here.

If you're aware that the quote "May you live in interesting times" is generally understood to be a curse (apocryphal or not), then you'll get our meaning when we say the current presidential election cycle has been an interesting one. But if we take a step back and consider the circumstances leading up to Dewey's 1948 "defeat" of Truman, or the "hanging chads" of the 2000 election, we can at least take some solace in knowing that the events of 2016 have so far been about as "interesting" as we could have fairly expected.

And as faithful students of trends, charts, and patterns of all kinds, we can always rely on our arsenal of data to make sense out of any apparent chaos. With 29 presidential elections having taken place since 1900, we have a respectable sample size from which to generate some hypotheses about how stocks might behave in this final run-up to the election, as well as in the days and weeks following the final tally.

Beginning with a very granular look, our first table below summarizes Dow Jones Industrial Average (DJIA) returns on Election Day, as well as the day immediately following. (Note that election days were holidays prior to 1984; for these cases, we looked at the last trading day prior to the vote.) Generally speaking, the Dow fares better than usual as citizens head to the polls, with stocks outperforming their "anytime" performance on nearly every front.

It's the exact opposite the day after the votes are tallied, with the post-election Dow performance falling short in just about every respect. While the Dow notches an average Election Day return of 0.74%, its mean return the day after is a loss of 0.17%, compared to an "anytime" advance of 0.03%. That said, when stocks are higher the day after a presidential vote, they're decisively higher -- by 1.48%, on average. Likewise, though, the average loss is also bigger, with this enhanced directional volatility reflected in the comparatively high standard deviation of 2.00%.

Drilling down on the two most recent presidential election cycles, the Dow was up 3.28% on Election Day 2008, and 1.02% in 2012. The day after the vote, the Dow dropped 5.05% in 2008, and 2.36% in 2012.

dow 1 day returns since 1900

Broadening the time frame, the two tables below illustrate how the Dow has fared during the two-week (10-day) and one-month (21-day) periods directly prior to the election, and directly after. Relative to "anytime" performance, returns are notably more bullish over both time frames in the period directly preceding the general election. Meanwhile, the two weeks immediately following the election tend to be a time of heightened volatility, per the standard deviation of 5.80% vs. 3.63% -- though this reverts back toward a more typical level of volatility over the full on-month stretch.

161027OA_DJIreturns2

From a seasonality perspective, it's important to remember that the November-April period is the strongest six-month stretch for stocks, and November-December is a particularly favorable two-month time frame. So, to get a better feel for the "election effect" more specifically, we tweaked the above analysis to replace the "anytime" category with the two-week and one-month periods bracketing the second Tuesday of November in each non-election year.

Looking first at the two-week results, it's interesting that the two-week period after a "non-election" November Tuesday is negative by an average of 0.42%, with less than half of the 87 returns in this category positive. By contrast, the two weeks after an election average a gain of 0.54%, with 51.7% positive returns. However, the 10 trading days after Nov. 8 this year could be more tumultuous than usual, as both the average positive and average negative returns over this time frame are more exaggerated than their counterparts in non-presidential election years.

dow 2 week election vs any november

As for the one-month time frames bracketing Election Day, it seems stocks tend to get a boost from an upcoming presidential election. The average Dow return in the month leading up to a presidential vote is a healthy 1.99%, compared to a nearly flat 0.02% move in other years of the election cycle. Pre-vote returns are also considerably less volatile in presidential election years, as is made clear by the standard deviation of just 3.81% (with an average negative return of 1.79%), compared to a steep 7.00% (with an average negative return of 6.72%) in years without a vote for president.

Notably, there's not too much of a difference in the two "month after" columns when it comes to average return, average positive, average negative, or standard deviation. There's a higher probability of a positive return over this time frame in years without a presidential vote, and the median return is higher -- but otherwise, it would seem to be more or less "business as usual" during this stretch of the calendar year, with traders appearing to move on pretty quickly after pricing in the results of the big vote.

dow 1 month election vs any november

Finally, the bold black line on chart below summarizes the action in the CBOE Volatility Index (VIX) in presidential election years since 1990. The returns from 2000 and 2008 weren't considered in the calculation, as bear markets in both years resulted in unusually elevated VIX readings; so, keep in mind that this average is based on a small sample size. But this graphic indicates that we can expect a VIX increase from here until Election Day, with a rapid drop-off after the event passes.

vix election day

As of the close on Thursday, Oct. 27, there are eight full trading days to go before the election results will be known. VIX has started to lift from its near-term low of 12.73 on Oct. 25, and history suggests we're likely in for more of the same over the next week and a half until the vote is in. Meanwhile, the Dow is down 0.9% from its close at 18,329.04 on Oct. 10.

Notably, a Google News search for "election anxiety" brings up 795,000 results, and anecdotal reports point to an unusually high level of stress associated with the current cycle relative to those of the recent past -- which could mean the odds are higher than usual for one of those relatively rare pre-election months with a negative return for stocks. If so, based on the average negative return of 1.79% for these time frames, we could see the Dow retest the 18,000 level before we learn the final outcome of Clinton vs. Trump.

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