Traditionally, stock volatility intensifies around election time. What does that mean for your investments?
The ringing in of a new president triggers a storm of uncertainty for everyone, but especially among investors. The effect a new administration has on taxes, for example, can potentially alter the returns investors will see in the post-election environment.
I can already see that for 2016, the presidential election may be causing an even more intense storm of uncertainty than ever. Whatever the outcome - Trump or Clinton - people are nervous about the political and financial aftermath of putting either candidate into office.
Now add to that turbulent mix the following current events...
1.the volatility spike we've already witnessed following the Brexit vote
2.rumors of a Federal Reserve rate hike
3.the aging bull market is due to start turning bear-ish
...and that can result in a very jittery group of investors this election year.
Just to provide a little more context, market volatility is defined by Investopedia as “the amount of uncertainty or risk about the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.”
So in the case of an election year, higher volatility also signals increased nervousness or indecision on the part of investors.
What Happens to Volatility During an Election Year?
All this anxiety translates into high market volatility, or so the theory goes. I can tell you from experience that election year volatility spikes are a common discussion thread among financial professionals, but does historical data prove this to be true? I did my research and discovered plenty of data to back up the theory.
One set of data spanning 1992-2002 shows a definite increase in volatility about six weeks before every presidential election during that time².
A Bloomberg analyst notes that Wall Street strategists agree, for once, on one thing: volatility is definitely in the cards for the end of 2016. He too cites historical data going back to 1992, showing the VIX (a measure of market volatility) index spiking every year except one.³
What About 2016?
For 2016, investors have every reason to be a little nervous. Volatility is indeed likely to occur, but the real heart of the matter is what should be done about volatility. What, if anything, can investors do to weather the storm of market uncertainty and the ensuing price fluctuation?
If you're looking for actionable strategies, keep in mind that the number one determining factor in your course of action over the next few months depends on whether you're a short-term or a long-term investor.
Investing for the Short Run?
If the market behaves in a similar fashion to the way it has in past election year environments, short term investors may want to scale back their market exposure. For now, that may mean putting hopes of seeing big gains on the back burner.
Regardless of the election, if you need money in the short term, say the next 3-5 years, I would limit equity exposure. The closer you come to needing funds, the less stock market exposure you will likely have.
Investing for the Long Run?
While short-term investors may have reason to strategize around election volatility, long-term investors can just sit tight as their strategy is for 15 or more years. This is where the old adage "Stay the Course" rings especially true. I am reminding my clients to keep a firm grip on what it means to be a long-term investor.
Election Volatility, in Perspective
Historically, the world has faced much bigger problems than election year speculation... and guess what: the markets have always recovered.
I can assure you: as bad as it seems that Donald and Hillary are the only two outcomes, and as scary as it seems that the Fed will raise rates, and as raw as our nerves may be after the recent Brexit-related volatility, our portfolios will survive. Just be sure to stay the course if you're investing for the long-term.
1.Vlastelica, Ryan. Will turbulent stock trading send investors flocking back to low-volatility funds?. MarketWatch. Retrieved 10/16/2016 from http://www.marketwatch.com/story/will-turbulent-stock-trading-send-investors-flocking-back-to-low-volatility-funds-2016-10-15
2.Bassman, Harley. Election Volatility on Steroids? PIMCO blog. Retrieved 10/16/2016 from http://blog.pimco.com/2016/03/08/election-volatility-on-steroids/
3.Regan, Michael P. No Debate on Wall Street: Election to Spur Volatility. Bloomberg. Retrieved 10/16/2016 from https://www.bloomberg.com/gadfly/articles/2016-09-26/clinton-trump-debate-wall-street-sees-volatility-ahead