History shows stocks rally during presidential elections

Contrary to the common adage "sell in May and go away," this year investors may be wise to sit tight and enjoy the ride. Although volatility may rise in the summer — especially in this not-so-ordinary election year — the S&P 500 index has historically traded with support leading up to the presidential election.

If the presidential hopefuls can spark hope of economic improvement, then we may see a sustained rally.

Donald Trump pauses as he speaks at his New York presidential primary night rally in Manhattan, April 19, 2016.
Shannon Stapleton | Reuters
Donald Trump pauses as he speaks at his New York presidential primary night rally in Manhattan, April 19, 2016.

Between the close of May and the close of October, the S&P 500 has rallied 19 of the last 22 election years (86 percent of the time) for an average gain of 6.2 percent. Although the stats for a rally look compelling, the results are skewed by significant volatility in a few election years.

The S&P 500 lost nearly 31 percent in 2008, while posting a 55.7 percent gain in 1932 and approximately 19.5 percent gains in 1936 and 1940. The median gain of 4.1 percent may be a more realistic measure. Nonetheless, the market has had a tendency to trade higher.

The S&P 500 has also traded strongly during the summer months of June, July and August, posting average monthly gains of 1.5 percent, 1.9 percent and 3.0 percent, respectively.

Prices were higher 77.3 percent of the time in June, just half of the time in July and 76.2 percent of the time in August. Across the period, stocks rose 76 percent of the time for an average return of 7.1 percent and median gain of 3.3 percent.

During presidential election years, the volatility of monthly returns tends to rise sharply in July and August.

The volatility of returns in July and August is 28.8 percent and 30.3 percent, respectively, compared with an average of 18.6 percent across the 12 months. Much of this volatility was driven by the 1932 election, which occurred in the face of the Great Depression, a tough economic period for the average American.

Given the contentious nature of this year's election and the lack of party unity in the Democratic and Republican camps, policy uncertainty could stoke volatility in line with or above historical norms.

This year's presidential election is likely to pit GOP businessman outsider Donald Trump against career Democratic politician and Washington insider Hillary Clinton.

"The restlessness and outrage of the electorate is driven by the slowest economic expansion since at least World War II and stagnating growth in median household income."

However, below the surface is an angry and polarized electorate, which saw Democratic candidate Bernie Sanders win 21 contests during the primary season and garner strong grassroots support despite the strength of the Clinton machine and Clinton's support among party elites.

Although Sanders is unlikely to grab the nomination, his significant voter support could influence the platform, and his popularity is a clear sign of voter discontent with the Democrat front-runner.

On the Republican side, Trump seemed to easily beat out the popular faces of the Republican Party without much of a fight, but insiders and congressional leaders have not rushed to embrace him.

The restlessness and outrage of the electorate is driven by the slowest economic expansion since at least World War II and stagnating growth in median household income.

GDP growth has averaged just 2.1 percent in the current expansion, versus a postwar expansion average of 4.1 percent. Real U.S. median household income peaked in 1999 before working flat from 1999 to 2007, and then trending steadily lower into 2014.

The markets will be watching to see if the politicians get the message and work to change business as usual in Washington during 2017. The markets could see dynamic and colorful political conventions next month, and the platforms may provide a signal for changes to come. Uncertainty could cause a freezing up of business activity as investment waits for the new landscape.

Will there be a further fueling of populism with more anti-Wall Street, tax-the-rich and higher minimum wage policy rhetoric to the direction of Sander's supporters, or will there be some type of big bang where regulation is loosened and animal spirits are encouraged from the White House under a Trump presidency?

Trump was quoted as favoring repealing parts of the Dodd-Frank Act and scrapping climate change rules, and he has met with the Reagan economics team. Moreover, there is potential change in trade deals with "fairer trade for America" gaining momentum.

The shift in trade has the potential to disrupt the flow of capital and goods. On trade, both Speaker Paul Ryan and Trump have talked about smarter international agreements. Foreign investors have a reason to get unnerved, given their distance from the U.S. political backdrop and the prospect of change.

However, the historically slow growth environment may leave little downside threat to economic policy change. Stocks like profit growth, so a change in economic policy that energizes the economy and spills into corporate profits should be easily embraced by stock market investors.

Hope springs eternal after elections. A charting of new waters has the chance to radically shift the investment landscape, and the stock market will be watching. Meaningful change, which reverses the economic trends that have fueled sluggish economic growth and an angry electorate, could unshackle the financial sector, lift median incomes, revive the consumer sector and unleash strong business investment.

A year from now, we'll see if the politicians in Washington have heeded the message of the electorate and worked to satisfy their voters. More of the same will keep the electorate outraged and frustrate equity market investors.

In the meantime, investors may want to embrace quality stocks. Quality stocks may have the ability to weather election year uncertainty and volatility, while potentially benefiting if the gears of growth pick up in 2017 on a new political landscape.