How the Presidential Election Could Destroy Your Investment Portfolio

Financial markets are notoriously unpredictable and volatile during elections, as investors negotiate the possibility of major political changes and economic shocks. The anticipation of a new administration fuels a frenzy of speculation that causes market swings that can unnerve even the most seasoned investors. Election cycles have historically been more volatile; for example, during the 2016 presidential election, the Dow Jones Industrial Average fell nearly 800 points overnight before rebounding sharply the next day. Similarly, the 2020 contest was rife with market volatility, reflecting the enormous uncertainty about the outcome.

Investors especially need to be aware of how political changes could impact their portfolios as the next election approaches.

Historical Performance Analysis

Examining stock market behavior during past U.S. presidential elections reveals distinct trends that often emerge before and after important events. Historical evidence shows that markets often exhibit greater volatility in the months leading up to elections, as uncertainty about the incoming administration’s policies creates a cautious investment environment.

For example, the S&P 500 fell significantly in the months leading up to the 2008 election, largely in response to the global financial crisis but also in part because of uncertainty about the candidates’ crisis management strategies. The market initially remained volatile after the election, but as the new government’s ideas began to take shape, it eventually calmed down.

Similar market swings occurred in the 2016 election; the Dow Jones Industrial Average fell sharply on election night as the results began to support Donald Trump, then rebounded and rose over the next few days as investors anticipated pro-business policies. The COVID-19 outbreak also caused significant market swings in the 2020 election, but the pandemic ultimately turned positive as investors responded to stimulus and vaccination breakthroughs.

Psychological impact on investors

The psychological impact of elections on traders and investors cannot be overstated. Elections provide a high degree of uncertainty that can cause emotional and often illogical behavior. Anxiety and fear of possible policy changes can cause investors to make hasty investment decisions or withdraw from the market early, thereby increasing volatility.

For example, the surprising outcome of the 2016 US presidential election triggered a tsunami of panic selling that reflected the initial market shock. However, as analysts assessed the expected economic policies of the new government, market sentiment changed dramatically and there was a noticeable reversal.

Similar trends have been seen in other major economies. One such example is the Brexit vote that took place in the UK in 2016. The unexpected vote to leave the European Union caused the FTSE 100 to fall sharply as investors were uncertain. As the consequences of Brexit became clear, the market changed, finding a new stability over time.

Volatility and stability in individual sectors

Different sectors react differently to uncertainty and election outcomes; some show greater volatility while others remain rather stable.

• Healthcare: Especially when candidates propose big changes to health care policy, the industry can sometimes be volatile during elections. For example, as investors weighed the possible effects of different health care policies from candidates, health care stocks fluctuated wildly in the 2020 contest.
• Energy: Particularly with regard to fossil fuel and renewable energy policy, the sector is quite susceptible to election outcomes. For example, energy stocks have surged in anticipation of the Trump administration’s pro-oil and deregulation policies.
• Technology: The tech industry has historically shown considerable stability and strength during elections. Still, policy ideas — such as data privacy rules or antitrust actions — can have an impact on the industry. Fears of more regulation have given tech stocks some volatility heading into the 2020 election.
• Financial: Financial stocks are also quite sensitive to election results, especially in response to legislative changes. The financial crisis caused initial declines in financial stocks after the 2008 elections, but as the new government introduced stabilization policies, they eventually rebounded.

Election Risk Factors

Investors face a number of risks during the election period that could have a significant impact on their portfolios:

One of the main risks is political uncertainty, or uncertainty about upcoming policies. Often with opposing economic and regulatory ideas, election campaigns leave investors wondering about the policy direction of the next government. As investors try to predict and react to possible outcomes, this uncertainty can cause market volatility.

Another major threat is changes in the regulatory environment. When it comes to rules affecting sectors such as finance, health care, energy and technology, different political parties tend to see things differently. A government that supports deregulation, for example, could help some industries while severely impacting others, depending on regulatory protections.

The election could result in significant changes in government spending priorities. For example, while cuts in healthcare spending could negatively impact the sector, increased infrastructure spending under one government could help the construction and materials industries. These possible events add another layer of uncertainty to investors.

Impact of election results

Different election outcomes could cause varying degrees of market disruption.

• Changes in political parties: Markets tend to react strongly when government power shifts between parties with different economic philosophies. For example, sectoral volatility can result from a change from a pro-business administration to one that emphasizes regulatory reform. Expected tax cuts and deregulation drove markets higher after the 2016 U.S. election, which produced a Republican president and Congress.
• Unexpected election events: markets are particularly sensitive to such events. One prominent example is the 2016 U.S. presidential election. Market forecasts and polls generally predicted a different outcome; when the actual results deviated from those expectations, markets experienced immediate and severe shocks. After an initial decline in futures markets, investors quickly recovered as they considered the implications of the new government’s policies.
• Changes in the legislative balance: Even though the presidency remains in the hands of the same party, major changes in the composition of Congress can affect market sentiment. A shift toward a more evenly divided or opposing Congress, for example, could cause parliamentary gridlock, thereby affecting the implementation of economic policy and generating more uncertainty.

Strategic Investment Approaches

Diversification is one of the best ways to reduce the risk of election-induced market volatility. Investors can reduce their exposure to any source of risk by spreading their investments across multiple asset classes, sectors and geographies. This method ensures that stability or gains in one area offset the negative impact in another. For example, a well-diversified portfolio across technology, consumer staples and international markets can help offset the impact if possible legislative changes were to severely impact the healthcare industry.

Hedging is protection against potential losses incurred using financial products such as inverse ETFs, options, or futures. Buying put options allows investors to hedge their portfolios; their value increases when the underlying asset decreases. This approach offers a type of protection against large market declines caused by unexpected election results or legislative changes. Inverse ETFs, which move opposite to the market, also help reduce negative risks.

Moving assets into stocks or defensive sectors can provide more stability in times of heightened uncertainty. By offering more stable performance, defensive industries like media, consumer staples, and healthcare tend to be less sensitive to political and economic cycles. Companies in these industries offer essential goods and services that are always in demand, regardless of the overall state of the economy.

Another smart strategy is to adjust your tactical asset allocation. Increasing your exposure to safe havens, including gold, Treasuries, or premium corporate bonds, can help combat market volatility during election periods. Typically holding onto value or even gaining in uncertain times, these assets help offset potential losses in more volatile stock markets.

Finally, during the election, it is important to maintain a long-term investment perspective. Reacting quickly to short-term market changes can result in less than ideal investment choices. Instead, focusing on long-term principles and investment expansion opportunities will allow you to profit from market changes after the election. After periods of political uncertainty, markets have historically tended to recover and remain on an upward slope. Staying the course and avoiding knee-jerk trading can help investors position themselves to profit from these long-term trends.

Application

All things considered, presidential elections have historically brought increased market volatility, political uncertainty, and sector risks that can have a major impact on investment portfolios. Further complicating the investment landscape during election seasons are the psychological effects on investors and the potential for significant market changes. However, strategic techniques such as diversification, hedging, switching to defensive industries, and maintaining a long-term perspective can help mitigate these risks.

Investors should focus on informed, strategic planning rather than running away from a crisis. Reviewing and changing investment plans helps to be prepared for possible market changes. Stay up-to-date with political events and market reactions to ensure your portfolio is prepared to negotiate the uncertainty of the upcoming election. Protecting and possibly improving your investments during this turbulent time will depend on proactive and informed decision-making.