Editors' pick: Originally published April 19.
Although prudent investors must fall back on basic investing fundamentals, the impact of the U.S. presidential election on investment portfolios can't be ignored.
Here are four factors that affect stock market performance amid presidential elections.
1. Presidential Election Cycle
The pre- and post-election periods typically have opposite effects on an investor's optimism.
An established theory called the "presidential election cycle theory" postulates that the financial markets exhibit weakening trends in the year following a presidential election.
In addition, a UBS report concluded that the S&P 500 moves from high to low and returns to high again for one complete cycle.
Many cycle lows happen during the first and second years of a presidential term, with most developing during the second year, according to the UBS report.
2. Elected Party
The economic policies of the elected party affect the nation's economic growth. The elected administration has control over fiscal policies that directly affect the revenue and spending patterns of the nation.
During the pre-election period, politicians tend to promote pro-business agendas, and once elected, their promises are put to the test.
A common myth is that markets react positively to a more business-friendly party. But the data show that stock markets actually perform better under Democratic presidents than Republican ones, with the exception of President Gerald Ford.
The Dow Jones Industrial Average has generated an average return of 82.7% during Democratic presidential administrations, compared with 44.7% under Republican ones. Usually, when different parties control the White House and Congress, stocks perform better.
A Republican Congress has usually been good news for the stock market, CNN Money reported.
But Russ Koesterich, chief investment strategist at BlackRock, wrote that whether a Democrat or Republican occupies the White House "holds no statistically significant impact on U.S. equity markets."
By looking at the annual price returns of the Dow industrials, Koesterich wrote that even though stocks have done better under a Democratic president, the positive impact is "dwarfed by the normal variation in annual equity market returns."
3. Uncertainty of the Outcome
An election year tends to create more market volatility because of the uncertainty of who will be elected.
The market tends to react more positively when the outcome of an election is fairly certain, according to a report from Merrill Lynch,
An academic paper also shows that the presidential election process creates market uncertainty as investors become anxious about future economic policy.
Another research paper demonstrates that market volatility decreases as investors get a clearer picture of who will an election.
4. Inherited Economic Situation
The reaction of the stock markets depends on the economic situation that a president inherits when taking office. The Dow industrials slumped more than 5% the day that President Barack Obama took office, though some of that drop is attributable to continuing concerns over the dismal economy that he had inherited.
Just a month after assuming office in January 2009, Obama signed the American Recovery and Reinvestment Act of 2009 in response to the Great Recession. That was followed by other laws during his administration, including the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.
The Dow industrials are now at about 18,000, compared with below 8,000 when Obama took office.
In conclusion, the stock market remains highly vulnerable to presidential elections and other uncertain external factors such as the Federal Reserve's monetary policy; oil prices; the possibility of the United Kingdom leaving the European Union, known as "Brexit";and problems in the eurozone.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.