History Favors an Election Correction for Stocks

No matter who you're pulling for in this year's presidential election, if you're an investor, don't bet on either candidate giving a lift to the stock market or your portfolio this year.

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The market may be in for an election correction.

"The assumption is that if the election is creating significant uncertainty, it would be visible in the stock market and then could be assumed to be having economic costs," says Ryan Sweet, a senior economist at Moody's Analytics.

Since 1945, the S&P 500 has gained 5.9%, on average, during presidential election years. But in the presidential elections in which neither candidate was an incumbent, the S&P declined by an average 3.3%.

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Sam Stovall, managing director of U.S. equity strategy at S&P Global Market Intelligence, who did the research, provides a ready explanation in a research note.

Uncertainty Begets Risk

"Why the startling difference? In general, Wall Street hates uncertainty," Stovall writes, echoing what Moody's Sweet said. "Second-term presidential elections generate leadership uncertainty, since both candidates are unknown quantities."

Mike Purdy, a historian who blogs at PresidentialHistory.com, studied what happens in year 8 of a president's term, going back to 1900. He found the S&P dropped an average of 1.2% during those years.

"(That) partially explains why there are so few 3-consecutive presidential terms for one party," he says, though he points out the sample size is small.

In a footnote to 2 of those years with declines, Chuck Fulkerson, director of education at Online Trading Academy, a stock investing and trading educational program, says they were influenced by other market conditions. In the case of 2000, the dot-com bubble burst; in 2008, the Great Recession began.

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Sweet doesn't necessarily see a correlation between non-incumbent elections and the market, but he says the 2016 election could have an impact on markets.

"This election has been unusual and contentious, suggesting that uncertainty could be higher and persist longer than in past election years," he says.

A Fiscal Strategy for First-Term Incumbents

It's a much different story during years when an incumbent is running for re-election. In the fourth year of a president's first term, Stovall found the SandP spiked by 10.2%, on average.

A pair of Pepperdine University researchers, Marshall Nickles and Nelson Granados, gauged the influence of sitting presidents running for re-election in a 2012 study.

"It is not surprising to see incumbent presidents push for votes by proposing tax reductions and or increasing spending on specific government programs as an election draws near," the researchers said.

In addition, a sitting president's party may even try to exert pressure on the Federal Reserve to bolster the economy through monetary policy, Nickles and Granados said. That can contribute to reduced risk for investors.

"If policymakers are successful in exerting positive influences on the economy as elections approach, it should be logical to expect less volatility in the stock market," the study said.

Non-Election Factors Have an Impact

In the current election year, factors unrelated to the campaign could jolt the economy and force a correction in the financial markets.

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Moody's Sweet says the Federal Reserve hasn't pushed back against the market's anticipation of falling interest rates. When it does, it could knock some of the wind out of the market.

"Eventually, the Fed will have to begin jawboning expectations higher," he says.

Other influencers having nothing to do with the election also may kick in.

In addition to Brexit, Great Britain's vote to exit the European Union, 3 huge factors could influence investors and the stock market for the rest of the year, according to Avinash Singh, senior manager of investment research for Aranca, a global analytics company.

First, there's the Chinese economy. It contributes 16% to global gross domestic product. China's slowdown in growth is coming at a rapid pace and "is likely to keep 2016 under pressure," Singh says.

And don't forget about oil prices, which have been zigzagging. "Some might argue that $30 a barrel is pretty much the floor. The volatility on the way up could still keep U.S. markets on the edge in 2016," he says.

Is the Market Ready to Peter Out?

Closer to home, the U.S. dollar has seen major gains in the past 12-15 months and the Fed is considering an interest rate hike his year. Either could stymie economic growth and the market.

To be sure, the market itself may prompt its own election correction if investors think it is overheated.

Presidential historian Purdy says making a prediction about how the election ultimately impacts stocks is so tough, given the unpopularity of both candidates.

Republican Donald Trump lacks policy and governing experience, and at times, stretches the bounds of civil decorum. Democratic rival Hillary Clinton has taken positions at times unfavorable to Wall Street.

"The markets are faced with the question of the devil you know versus the devil you don't know," Purdy says.

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