How Do Political Conditions Affect the Stock Market?
Between terrorist attacks, worries of nuclear war and extreme weather events, there have been plenty of harrowing news events in recent months that have been followed by precipitous drops in the stock market. After the terrorist attacks in Barcelona, Spain in August, the Dow Jones Industrial Average dropped 275 points.
Despite all the troubling news, the Dow is still up about 13 percent this year. How can this be? Supporters of President Donald Trump point to his business-friendly policies to explain the jump, while his detractors say others factors are at play. So which is it? And what can investors do during these times of turmoil?
It’s Complicated
The short answer? There’s a complicated relationship between political conditions and the stock market. There have been times that politics seemed to have a direct impact on the markets. Take the “Romney Rally,” for instance — when the stock market rose, absent any other obvious cause, the day after Mitt Romney was widely considered to have won a presidential debate in 2012.
As a general rule, however, “politics have very little effect on the stock market other than short-term knee-jerk reactions,” said Karyn Cavanaugh, Voya Investment Management senior vice president. Cavanaugh pointed to both Brexit and the 2016 presidential election as political events that had investors worried, but which failed to result in a sustained dip in the market. There were still lessons to be learned from the momentous events of 2016.
Short-Term vs. Long-Term Effects
When considering whether politics impacts the market, it is important to differentiate between short-term and long-term effects.
Investors are sometimes cheered by the election of a candidate, such as Trump, who seems likely to roll back regulations and embrace corporate tax reform. But what is good in the short term may not always be good in the long term. For example, investor Jack Bogle predicted at the outset of the Trump administration that the president’s proposed infrastructure spending would be good for the economy in the short term but would be detrimental to the economy, stock market and society over the long run.
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Jeffrey Hirsh, CEO of Hirsh Holdings and editor-in-chief of “Stock Trader’s Almanac,” said the pace of the modern media environment mutes the impact of most individual events on the market. “There’s so much out there right now in the media that the market doesn’t seem to be impacted by it,” he said. “Short-term impacts are being less and less felt with our 24/7, 140-character world. Terrorism events and these weather calamities used to give the market a pretty big hit, but we now seem to be much more resilient to these events. We’re more used to them now — this is the new world we live in.” Tuning out the noise is one secret to becoming a great investor.
What Does Move Markets?
One thing is certain: The stock market doesn’t like uncertainty. On Sept. 5 of this year, the Dow dropped 234 points amid a series of potentially volatile political events, including the debate over raising the debt ceiling, a possible government shutdown, and threats from Trump over trade policy with China. That was a month after the Dow hit a new all-time high.
But factors other than political ones were at play as well, including a big (5 percent) drop in shares of defense behemoth United Technologies after it announced plans to buy another company for what some analysts deemed an exorbitant price. Among the many factors that influence stock market gains and losses are company earnings, interest rates and expectations for the world economy. It pays to be aware of the context of a market drop, and not ascribe too much meaning to any one event.
“The true driver of markets is corporate earnings growth,” Cavanaugh said. “If companies can continue to move the ball forward and continue to grow their profits, the market will follow. I call corporate earnings the canary in the coal mine. That canary is singing, not wheezing, and that is why markets are moving higher.”
Learn More: How to Use Quarterly Earnings Reports to Your Advantage
Advice for Investors
So what should this mean for your investment strategy? Investors shouldn’t get too caught up in every twist and turn of the stock market, experts say, and should keep their big-picture investment strategies in mind as they weather fluctuations due to political events.
“I tell investors to not try to ‘Washington Proof’ their portfolios,” Cavanaugh said. “Think about the political crises over the last few years — sequestration, fiscal cliff, debt ceiling — that all turned out to be non-events.” No matter who is in the Oval Office, there are stocks that are smart and stable investments.
Cavanaugh advises investors to remember that corporate earnings, not politics, move the market. “The only time politics will affect markets is when they alter the economic landscape where companies are doing business,” she said. “So my rule of thumb: Until the politics materially change the way companies are doing business, investors need to put the drama on the back burner.
“Investors should remember that even under positive economic conditions and robust fundamentals, markets normally experience corrections two or three times a year,” Cavanaugh added. “So remaining globally diversified across stocks and bonds is always a good idea to help ride out the inevitable ups and downs.”
Related: 20 Things to Do in a Falling Stock Market
Advice for Politicians
Investment professionals also counsel against politicians taking credit for stock market surges, or blaming their opponents for market dips.
To wit, in the months after former President Barack Obama’s election in 2008, the market was dropping quickly. Some conservatives claimed the drop was due to investors’ fears of Obama’s policies, and tried to tie Obama to the fate of the stock market. But Obama’s election coincided with the Great Recession, which had a big negative impact on stocks. When the stock market started a bull run later in Obama’s term, the air was taken out of the idea that the president was to blame for the dip, especially since none of his fiscal policies changed.
A danger of taking credit for stock market highs (like Trump did this summer, when he tweeted “U.S. Stock Market up almost 20% since Election!”) is that politicians then own any ensuing lows. Once politicians tie themselves to fluctuations in the market, they own it — for better or for worse.
If politicians want to take credit for market gains, investors and the public should take the politicians’ crowing with a (large) grain of salt. “Washington should not be taking credit for ups and downs in the market,” Cavanaugh said. “Washington policy should work to create a positive economic backdrop. Then it’s up to the corporations to make hay.”
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