How to Take Advantage of Fear, Then Relief in the Stk Market Leading up to the Presidental Election

This article originally appeared on MarketWatch here.

The U.S. stock market will fight stiff headwinds in the months leading to Election Day in November 2020. But the fear that’s transfixing investors on both sides will turn to relief for supporters of the winning party once the outcome is known. At that point the headwind will quickly shift to a tailwind, as those on the winning side put money to work and drive markets higher.

Until then, investors may have to muddle through the fourth year of Donald Trump’s presidency. For any president, the fourth year is typically characterized by weak markets. Our analysis of past election cycles shows stock market declines usually last until the resolution of the election is known (which may come prior to Election Day) and is then followed by a “relief” rally. This has been the case in every election cycle dating back to Reagan versus Mondale in 1984.

This is a challenging juncture because the fundamentals of the U.S. economy are solid, market valuations are fair and many stocks are offering compelling valuations. Beyond that, major 15- to 20-year cycles alternate between deep despair and significantly over-extended market and economic booms. We can debate if we are more or less than halfway through that cycle, but we have not seen the usual exuberance that typically marks the top of a cycle.

But against that positive long-term view, the psychological factors weighing on the markets today can be expected to remain particularly daunting. The upcoming election is only one more significant factor to consider.

The period leading up to a presidential election is always tricky. This election cycle in particular offers more challenges than most. Between 1984 and 2016, the hard policy distinctions between the parties were subtle. Not in 2020. For the first time in a long time there is a quantum difference in policy approaches between credible candidates. That is going to be a tough reality for investors to work through. On top of that, the attempted impeachment of President Trump will generate headlines for the foreseeable future. Regardless of whether you think it is right or wrong, or where you want to lay blame, it does not make for an easy investment climate.

First, fear …

Stock market performance tends to weaken during the fourth year of a presidential term because investors on both sides of the political spectrum become paralyzed. Each side fears what will happen if the other wins, so no one wants to put money to work. Consequently, nobody is confident until they know which way the election will go.

… then relief

Once the outcome becomes clear, half of us remain worried. The other half breathes a sigh of relief and puts money to work, and the pause around the election ends.

Looked at that way, one would expect markets to struggle for some period before the election and then to advance once the results are known.