How should my portfolio be allocated as the election nears? Should I re-allocate now in anticipation of election results or wait until the election is decided before making adjustments? Should I put excess cash to work now or wait until 2013? These are questions investors are asking as the November election nears. David G. Booth of Dimensional Fund Advisors analyzed this same issue in an article in 2004. Booth analyzed five return relationships* within stock and bond allocations for the five months leading up to and twelve months following a presidential election.

 

The results supported the following findings:

 

  • There was not a noticeable difference in the average monthly returns in presidential election years compared to average monthly returns of all other years.
  • The incumbent does benefit from strength in the stock and bond markets in the five months leading up to an election.
  • If the stock and bond market return relationships were negative in the October before the election, the incumbent lost the re-election bid.
  • Regardless of an incumbent victory or loss, stock and bond markets return to a normal state in the twelve months following the election.

 

Elections are emotional events and it is very easy to allow positive or negative emotions to drive investment decisions. While the data suggests a rising stock and bond market leading up to an election can favor an incumbent, it also suggests an incumbent should be wary of an investor’s negative experience occurring in the month before the election. The bottom line is, regardless of whether an incumbent is re-elected or not, historical evidence shows market performance returning to a normal state in the twelve months following an election. It cannot be emphasized enough that, when approaching uncertain events, the disciplines of diversification and thoughtful portfolio construction will fare better than attempting to time the markets.

 

*Stock and Bond Return Relationships defined as:

 

Market factor: Stock market return above Treasury bills

 

Size factor: Small cap minus large cap returns

 

Price factor: Low-priced minus high-priced stock return, where price is scaled by book value

 

Term premium: Treasury bond minus Treasury bill return

 

Credit Premium: Corporate bond minus Treasury bond return