Navigating Election Year Volatility

Insights into Market Trends and Strategies for Long-Term Investors

The performance of investment markets during election years can vary widely, and it’s essential to note that many factors influence market trends. However, historical patterns suggest that markets often experience increased volatility in election years.

Some of our general observations include:

1. Initial Uncertainty: In the months leading up to a presidential election, the markets tend to exhibit heightened volatility due to uncertainty about the potential policy changes that could result from a new administration.
2. Policy Impact: The market’s reaction also depends on the economic policies proposed by the current, and potentially new, administrations. Certain sectors or industries may benefit from new policies, while others may face challenges.
3. Long-Term Trends: While presidential elections can create short-term fluctuations, the performance of investment markets is influenced by various economic factors, global events, and monetary policies over the long term.

In past election years, the S&P 500 stock market index has seen more positive performance than negative. Since 1940, 18 of the 21 years (86%) provided positive performance. The S&P 500 has averaged a +9.9% gain during US presidential election years, which is below the average annual return (12.5%) for the S&P 500 during all years since 1940. It is worth noting that the S&P 500 has not declined during a presidential re-election year since 1940.

In 2024, we face a new set of uncertainties that will challenge markets, and the months leading up to the election may prove to be unpredictable and volatile. We expect markets to ebb and flow as the Federal Reserve tries to curb inflation and geopolitical tensions continue to add an element of uncertainty. However, while there are areas of caution, we see a broad range of opportunities across the equity market. Additionally, bond yields remain high. The last three years saw market returns of +/- 15-20% each year, but we are cautiously optimistic and expect markets to deliver more typical returns going forward.

Individual election years may deviate from historical patterns, as each election cycle has its own unique circumstances. At Greenleaf Trust, we think it’s crucial for investors to diversify their portfolios and consider a long-term perspective, rather than make decisions based solely on election-related events.

The importance of (1) diversification in your portfolio and (2) patience to stay the course.

Diversification is a fundamental strategy in investment management that involves spreading investments across different asset classes, industries, or geographic regions to reduce risk. The importance of diversification in an investment portfolio lies in its ability to lower risk through several key mechanisms.

1. Risk Management: Different asset classes and investments often react differently to various economic conditions and market events. By holding a diversified portfolio, the impact of poor performance in one investment or sector is mitigated by the potential positive performance of others. This helps reduce the overall risk of the portfolio.
2. Minimization of Concentration Risk: Concentrating investments in a single asset or asset class exposes the portfolio to specific risks associated with that investment. Diversification helps minimize concentration risk, ensuring that the impact of a major event on one investment is limited.
3. Enhanced Return Potential: While the primary goal of diversification is risk reduction, it can also contribute to the potential for better returns. A balanced and diversified portfolio has the opportunity to capture gains from different sources, leading to more consistent and stable long-term performance.

Diversification can also play a role in managing investor psychology. Holding a well-diversified portfolio can help investors stay disciplined during market fluctuations, which tend to increase during presidential election years.

Patience and staying the course are essential virtues for investors aiming to maximize long-term investment returns. Here are several reasons these qualities are crucial.

1. Time in the Market: Successful investing often involves staying invested for the long term. The longer an investor remains in the market, the more opportunities they have to benefit from compounding returns. Patience allows investors to weather short-term volatility and capture the potential for long-term growth.
2. Avoiding Emotional Decisions: Emotional reactions to market events can lead to poor investment decisions. Staying the course involves resisting the urge to make impulsive moves. Patience allows investors to make decisions based on a rational assessment of their financial goals.
3. Long-Term Trends: Markets go through cycles, and long-term trends tend to prevail despite short-term fluctuations. Patience enables investors to focus on the big picture.

In summary, patience is a critical component of a successful long-term investment strategy. At Greenleaf Trust, we build portfolios for the long-term, constructed with business cycles, recessions, and even presidential elections in mind.