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Post-Election Jubilation

Published by: Nathan Smith Date: November 09, 2018

Finally, the election has come and passed, and everyone in the country can unite in the fact that we can watch television again without watching campaign ads.  They became so repetitive that my family invented a game where we all guessed at which candidate would be next on television and if it would be an ad for or against them.  In the aftermath of the election, both sides have claimed victory, which means in reality that neither of them won.  With Congress in gridlock now, the market is coming to terms with the idea of what the next two years might hold.  Regarding what has happened in past presidential cycles, the third year of a presidential term on average is the best performing of the four.

Source: DFA Returns 2.0

Conceptually this idea makes sense as the midterm elections tend to bring lots of uncertainty to the markets, especially when you have had a contentious first two years as we have seen since 2016.  The markets question whether or not recent legislation could be repealed, how much government spending could be impacted, how foreign policy actions could affect issues from global trade all the way to the supply and demand expectations in the oil markets, etc.  With each new poll the market can swing wildly depending on the perceived outcome, but in the end, the market and its million of participants assess each data point of information and factor in the likelihood of the outcome.

So now that we are out of the election woods can investors look forward to a great year 3 in 2019?

The chart above would tell you that the third year of a president’s term tends to be the best performing on average than the others, but there is more to this number than meets the eye.  It doesn’t take a statistics whiz to see the problem with the data besides there not being enough of it, is the vast range of outcomes.  As noted in the graphic below, there was a year in which the return was -43.3%, and that has a significant impact on the range of potential outcomes.  Now, this isn’t to say that I think the market will be up or down next year, all I am stating is that the probability of a down year in the context of this data isn’t insignificant, and investors shouldn’t be lured into making investment decisions based on an insufficient number of data points.

Source: DFA Returns 2.0 

What investors should focus on is investing with purpose and meaning in funds and strategies that have been strenuously tested by hundreds of researchers over the decades to come up with statistically significant factors and cost-effective ways in which investors can capture higher than expected returns over the long-term.  These factors of performance are the following:

Equity:  Stocks outperform bonds over long periods of time   

Size:  Small companies outperform large companies over long periods of time    

Price:  Value companies outperform growth companies over long periods of time    

Profitability:  High profitability outperforms low profitability over long periods of time 

As the nation takes a collective sigh of relief and enjoys the next two years of political ad-free viewing, investors that are looking to make changes to their portfolios based off the current political climate should heed the advice of Warren Buffett when he said: “Don’t mix your politics with your investment decisions.”  Investors should continue to focus on the statistically proven drivers of market returns, and not which year of a presidential cycle we are getting ready to go through.

Nathan Smith is Portfolio Manager at Rather & Kittrell, and can be reached at nsmith@rkcapital.com.