How will the US Presidential election affect the stock market?

Is the US Presidential Cycle tradable?

Another point about the presidential election concerns the Presidential Cycle. Leaders are tempted to spend more ahead of the election to improve (or ‘juice’) the economy. In turn, the electorate may be imbued with the ‘feel good’ factor and vote for the current party. In the US, the cycle runs like this. In the early years of a presidential term, stock returns are lower. Then stock prices rise in the second/third year and then tapered off in the last. The fund house GMO did several studies about this and found that during the Year 3 of a presidential term, stock returns are relatively higher than other periods combined. The founder of GMO concluded that:

The important fact here (see Exhibit 1) is that for 7 months of the Presidential Cycle, from October 1^st of the second year (this cycle, 2022) through April 30^th of the third year (2023), the returns, since 1932, equal those of the remaining 41 months of the cycle! This has a less than one-in-a-million probability of occurring by chance, pretty remarkably, and it has been about as powerful in the last 45 years as the previous 45 years.

In other words, perhaps who occupies the White House is less important than what happens after the presidency begins.

Do US Presidential Elections impact FX markets?

The direct effect of the US election cycle on the international currency market is murkier. Two reasons complicate the analysis in the foreign exchange markets. The first is that all FX rates are relative comparison between two sovereign nations. Some pairs may appreciate; while others decline. The directional trend of each FX rate depends on a relative comparison of the economic strength of two countries. The US economy and political cycles are stacked on only one side of the equation.

The second factor is interest rates. Again, this depends on the economic performance of the two countries at that time. Other countries may be experiencing financial crises that makes the US Dollar more attractive, regardless of who is winning the US election. One example is the Global Financial Crisis in 2008. Furthermore, central banks these days have greater operational independence. This means more monetary policy continuity than in the past. Many Fed chairs’ term in office spread across presidencies of different parties. This blurs the impact of party-effect on FX rates.

Still, some studies have been done on the impact of the US elections on USD pairs. In one, Corte and Fu (2024, link to paper) analyse the impact of political parties on the USD strength. They found that:

US presidential cycles can predict dollar-based exchange rate returns. Armed with more than 40 years of data and a large cross-section of currency pairs, we document an average US dollar appreciation during Democratic presidential terms and an average US dollar depreciation during Republican presidential mandates. The difference in these average exchange rate returns is larger than 5% per annum and is primarily linked to trade tariffs.

Note that the returns in the paper are aggregated across all Democratic and Republican terms. Whether or not this higher Democrats-enhanced return can be projected into a new presidential term is difficult to say. The authors did try to use simple FX trading strategies to assess impact of US parties on USD performance (see below, perhaps see the original paper for a further exposition).

Source: Cortes and Fu (2024)

Concluding Remarks

The US election is an important macro factor that sways asset prices. However the impact of each election cycle is different. Just because X or Y rallied in the last election does not mean they will do so again. The only consistent observation regarding the US presidential terms is the Presidential Cycle.

For traders, the important thing is not so much, who is winning, but what the market’s reaction to the looming presidency. Remember the stock market already incorporates, or ‘bakes in’ so to speak, much of the current and near-term information. With less than a month to the US election, the S&P is hitting new all-time highs. This ought to tell us something. The market senses that the next occupant of White House will be good for the market. Follow the trend.