Do elections really influence the stock market? What investors should know

Few events generate as much discussion and uncertainty in financial markets as an election. Whether voters are choosing a president, electing members of Congress, deciding state legislative races or selecting local officials, election results can have implications for taxes, government spending, business regulation and economic policy. Investors naturally wonder whether those outcomes will influence the direction of the stock market.

Does the market perform better when Republicans control Washington or when Democrats are in power? Does a divided government create a more favorable environment for investors? And should investors adjust their portfolios ahead of an election? While elections can certainly influence financial markets, the historical evidence suggests that political party control is a much less reliable predictor of investment returns than many people assume.

What does history tell us about elections and market performance?

When examining historical stock market returns, one interesting pattern involves midterm elections. Midterm elections occur halfway through a presidential term and determine the composition of Congress, including all seats in the House of Representatives and approximately one-third of the Senate.

Historically, midterm election years have been associated with somewhat weaker stock market returns and greater volatility. According to J.P. Morgan Asset Management, the S&P 500 produced average annual total returns of approximately 9.2% during midterm years since 1937, compared with 13.3% during non-midterm years. However, the year following a midterm election has historically been stronger, with the market gaining an average of 6.6% in the fourth quarter of midterm years alone.

Fidelity's research also found that the S&P 500 generated positive returns in the 12 months following 95% of midterm elections dating back to 1938. While these statistics are interesting, they do not establish that elections cause markets to rise or that investors should change their portfolios in anticipation of a particular outcome.

In fact, some of the weakest midterm election years in recent history were driven by factors that had little to do with politics. The market declines in 2018 and 2022, for example, were heavily influenced by rising interest rates and Federal Reserve policy. This illustrates why it is important to look beyond election headlines when evaluating market performance.

Does it matter which political party controls Congress?

Investors often debate whether financial markets perform better under Republican or Democratic control. Another common argument is that markets prefer divided government, where one party controls the presidency and another controls at least one chamber of Congress.

The theory behind divided government is that it can limit sweeping legislative changes and create a more predictable policy environment for businesses. Others argue that unified government can be beneficial because it allows legislation to move forward more efficiently.

Historical market data produces different results depending on the time period and methodology used. Some studies show stronger average returns under certain combinations of party control, while others find little evidence that political configuration provides a dependable indication of future performance. J.P. Morgan's historical analysis, for example, emphasizes that economic growth, monetary policy, corporate profits and market valuations are more useful indicators of investment conditions than political control alone.

The important distinction is that historical averages do not necessarily explain why markets performed the way they did. A particular political party may have been in power during a period of strong economic growth, but that does not mean its policies were solely responsible for the market's performance. Interest rates, inflation, technological innovation, consumer spending and global economic conditions all play important roles.

Politics can affect certain industries more than the overall market

While elections may not provide a reliable indication of overall stock market direction, government policy can have a meaningful impact on individual industries and companies.

Changes in energy policy can influence traditional energy producers and renewable energy companies. Healthcare legislation can affect pharmaceutical companies, hospitals and insurance providers. Tax legislation can influence corporate profitability, while tariffs and trade agreements can affect manufacturers, retailers and businesses with international supply chains.

State and local elections can also matter. Decisions involving property taxes, infrastructure spending, utility regulation, economic development incentives and business regulations can have meaningful consequences for companies operating in specific regions.

This is where investors should distinguish between the overall stock market and individual sectors. An election may create opportunities and challenges for particular businesses without necessarily determining the direction of the broader market.

Markets dislike uncertainty more than election results

One of the more interesting observations about elections is that financial markets often respond more to uncertainty surrounding an election than to the actual outcome.

Leading up to an election, investors are attempting to evaluate numerous potential policy changes. Campaign promises, proposed legislation and competing economic agendas create uncertainty about what the business environment may look like in the future.

Once the election is over and the results become clearer, investors can begin evaluating the actual policy landscape rather than speculating about several possible outcomes. Fidelity's recent analysis of midterm elections suggests that the resolution of uncertainty has historically been more important to broad market performance than which party ultimately wins control of Congress.

That does not mean markets always rise following an election. Unexpected results or proposed policy changes can certainly create volatility. It does help explain why markets sometimes perform well even when the election outcome is not what investors initially expected.

The cost of investing based on politics

Perhaps the biggest mistake investors can make is allowing their political beliefs to dictate their investment decisions.

Imagine an investor who believes the stock market will struggle because a particular political party has gained control of Congress. They decide to move their retirement portfolio into cash and wait until the political environment improves.

The problem is that markets rarely wait for political uncertainty to disappear. They can rise despite unfavorable headlines, fall during periods of political optimism and react to economic developments that have little connection to Washington.

Investors who move in and out of the market based on political expectations risk missing some of the strongest market days. Over long periods, those missed opportunities can have a meaningful impact on portfolio performance.

Focus on what you can control

Rather than trying to predict which political party or election outcome will produce the best market returns, investors are generally better served by focusing on the factors they can control.

That means maintaining an appropriate asset allocation, diversifying across different asset classes and geographic markets, managing investment expenses, being intentional about taxes and maintaining a long-term investment strategy.

Political developments should not be ignored. Tax legislation, regulatory changes and government spending can have meaningful implications for financial planning and investment portfolios. Those developments should be evaluated based on their actual economic and financial consequences rather than political affiliation alone.

The bottom line

Elections matter. The individuals elected to Congress, state legislatures and local offices can influence the economy, the tax code and specific industries. However, history does not provide a dependable formula for predicting stock market performance based on which political party wins an election or controls a particular branch of government.

The stock market has experienced periods of strong growth and significant declines under both Republican and Democratic leadership. It has performed well under both unified and divided government, and it has endured economic challenges regardless of who holds political office.

As investors, we should pay attention to what is happening in Washington and across the country without allowing every election to change our investment strategy.

Your long-term financial success is unlikely to depend on the outcome of any single election. It is much more likely to depend on having a sound financial plan, maintaining a diversified portfolio and staying disciplined through the inevitable uncertainty that comes with investing.

Reid Schwartz is a columnist for The Item and Co-Founder of Creech Schwartz Wealth Management &Partners in Sumter, where he works as a financial advisor helping individuals, families, businesses, and nonprofits plan for long-term financial success.

*Tax and accountancy services are not available through or provided by Creech Schwartz Wealth Management or &Partners LLC.

This article is for educational purposes only and not to be interpreted as tax or legal advice. Any tax planning strategies discussed by Creech Schwartz Wealth Management will be in conjunction with your tax/legal professional. Past performance is not indicative of future results. Asset allocation does not guarantee a profit, nor does diversification protect against loss.

Securities and investment advisory services offered through &Partners LLC, a broker-dealer and investment adviser registered with the U.S. Securities and Exchange Commission and member FINRA, SIPC.