Navigate the US Election and its Impact on Investments with Morningstar Direct

Eden Alemayehu: Hi everyone! My name is Eden Alemayehu, and I am a product marketer for Morningstar Direct. I'm here today with Tom Nations, director of research and content and Dan Lefkowitz, strategist for Morningstar Indexes. 

We're excited to discuss the upcoming US election and how investors can prepare for it, considering its potential impact on market performance. 

Dan, you've published research looking at investment performance after recent elections. Can you share more about it? 

Dan Lefkovitz: Sure. So back in April we published a paper looking at recent elections and how they've impacted financial markets using Morningstar's index ratings. 

To be candid, I had some conferences in Europe over the summer months, and I was anticipating getting asked about US elections as the token American, and I wanted to answer in a data driven way, not just speculate. 

So we looked at the Morningstar US Market Index and the Morningstar US Core Bond Index and how they reacted after the 2016 election and the 2020 election. Of course, that research was published in April, we thought the matchup was set. Trump versus Biden provided the unique circumstance of two candidates who had won before. And, of course, as you all know, nothing has really changed since then. 

Eden Alemayehu: So, from your research, how have US elections affected market performance? 

Dan Lefkovitz: Yeah, well, that's a big question. I think, you know, generally speaking, politics and elections--they do matter. Taxing and spending matter, policy regulation, trade practices, it all matters. And we've actually seen, you know, in 2024, we've seen elections move markets pretty substantially. 2024 is a big year for elections, not just in the US but across the globe. And we've seen big market moves after election results in India, in Mexico, in South Africa and in France, especially when the election results are a surprise, and they're not anticipated by the markets, and they're not priced into asset prices. 

But I'd say that over the long-term, fundamentals matter more than politics and elections. So, you know, corporate earnings and cash flows and valuations Are, you know, you're going to want to put more emphasis on those. Of course, politics are variables that influence those things, but they're, you know, they're just some of many, many forces that are impacting asset prices. 

Eden Alemayehu: And so you've mentioned some of those variables. I want to take a moment to look at the 2016 and 2020 elections. What were the immediate market reaction to both of those events? 

Dan Lefkovitz: Yeah, so really interesting. If you look at the US Equity market, there was a huge rally in the small cap value segment of the US Equity Market after both the Trump election in 2016, and the Biden election in 2020, kind of for different reasons. So, 2016, we saw a pretty significant rally in the US Equity Market overall. It was known at the time as the Trump bump. 

Of course, that election result was a surprise to a lot of investors, and the biggest beneficiaries in the equity market were in the small cap value segment of the Morningstar Style Box, and our small cap value index was the best performer in November and December 2020. So, if you think about, you know, the Trump agenda, the Trump campaign platform in 2016, you know, he wanted to stimulate economic growth. He wanted tax cuts, regulatory rollbacks, infrastructure, spending, obviously a clampdown on immigration. 

So, the kinds of sectors and the kinds of stocks that benefited most were kind of economically sensitive interest rate, sensitive, domestically oriented in their revenues. Think about sectors like financial services and energy and basic materials industrials. Those were the biggest beneficiaries after the Trump election in 2016. 

Now, if we fast forward four years, the Biden election, there was also a big rally in the in the small cap value segment of the US Equity Market. 

But it's hard to separate the results of the election from other things that were going on. And this is, I think, a broader, you know, takeaway from this conversation is that there's always a lot going on. There's always many variables that are interacting to drive markets. And elections and politics are just one of them.  

But in 2020 the big driver was the vaccine rollouts. So of course, it was the pandemic and what it was called at the time was the reopening trade, so economically sensitive types of stocks that were perceived beneficiaries from the end of Covid lockdowns, they rallied the most in in 2020.  

Oh, I forgot to mention a couple of other assets in 2016 that really moved based on the election. We saw a big spike in bond yields. So our core bond, Morningstar US Core Bond Index fell after the Trump election on anticipation of stimulus inflation rate hikes, and then we saw the Morningstar Russia Index climb, and the Morningstar Mexico Index. Those are equity indexes fall after the Trump election. 

Eden Alemayehu: So, looking even at the short term, we see that a lot has happened when we think about long-term market. Of these two administrations, what are our thoughts here? 

Dan Lefkovitz: Yeah, well, this is really interesting. So, the initial reactions to the 2016 and 2020 elections did not persist. So, if you look at 2016, I mentioned small cap value. That was the biggest style box beneficiary. By 2017, large cap growth was back on top. 

So, you know, key planks of the Trump agenda failed to advance like infrastructure spending. You know. Another thing I didn't mention was that big tech did not perform well right after that Trump bump period of 2016. But technology was the best performing sector over the Trump administration. I don't think it had much to do with politics or the administration. It was the fundamentals of the technology companies. And you know, larger trends in society. If you look at, you know, Biden, that small cap value rally in 2020 faded as well, and the best performing equity sector under Biden has been so far traditional energy. 

So, despite the Biden Administration's, you know, emphasis on renewables and the inflation reduction act, traditional energy stocks, fossil fuel, related businesses and oil and gas have performed the best. So, I think that's another key takeaway is that, you know, the market's going to do what the market's going to do, and the sectors that have performed best under the administrations aren't necessarily what you'd expect. Given their policies. 

Tom Nations: Right, maybe, just to emphasize Dan's point, too. It's like there are marketers, expectations for pretty much everything right, whether it's elections or GDP prints or inflation, or whatever it's what the actual data that comes through that actually impacts performance. Right? 2016 Election, Trump was very much surprised. The market reacted swiftly in one direction that didn't necessarily persist, you know. And you think about what happened in 2020 sort of a coin flip in the election, you know, buying ends up winning. But of course, you know, Dan mentions the reopening trade that had been going on for some time, like, I distinctly remember the market shifting. 

November 8th or 9th 2020, when the Pfizer vaccine announcement came out, and the market just completely changed in terms of like what was leading it. What was the most important thing at any given moment, I mean, the other thing to think about, too, is like there's more than just presidential elections going on right? So, like, the President can win, but the House can shift. The Senate can shift, which also dictates how much policy they'll be able to get through, which also dictates what regulation and everything will look like from a government spending perspective. So, there's so many factors at play with all these, and you know, being able to model all them, and, you know, provide one pattern for all these going forward is very difficult. 

Yeah, but that's kind of the key value of Dan's analysis is that he's kind of done historical analysis. See how markets have responded, both in the short term, but then also kind of have those trends persisted, going forward. 

Eden Alemayehu: Taking all of that into account with our short term and long-term implications, along with the fundamentals that are consistent throughout it all, can we look at history to predict what's coming up when it comes to Trump and Harris? How do you go about that? 

Dan Lefkovitz: Right? Well, you could. You know you could look at the policies and say, well, okay, you know, Trump likes tariffs. He doesn't like taxes. He doesn't like immigration. 

You know, Harris wants to crack down on price gouging. She wants to raise the corporate tax rate to 28%. But, as Tom just said, you know, a lot of those policies will require congressional activity. And who knows, you know, who knows what the election result is going to be at the presidential level. And then who knows what it's going to be at the congressional level as well? 

You know, at this moment, the race sort of seems like a toss up. That Trump bump that we saw in 2016, you know, just because it happened before doesn't mean it's going to happen again. Markets are constantly learning and adapting. So, I think you know, making a big bet on the results is tricky business and then making a bet on how the market's going to react and what the policy implications are, going to be just sort of ratchets up the level of difficulty. 

Eden Alemayehu: So, knowing how difficult all of this is to predict. Would you say there is a party that is better for market returns? 

Dan Lefkovitz: I think it's really important for investors to remember that markets have thrived under political administrations of all stripes. Markets have also crashed under all sorts of administrations. You know, there are a lot of sort of behavioral pitfalls that investors can fall into, you know, thinking that everything's going to go to hell in a handbasket if their candidate, you know, does not get into power. You know, that can really lead investors astray. Now we did look at the performance of US Stocks and US Bonds using our Morningstar US Market Index to gauge, to proxy the Equity Market and our Core Bond Index, to gauge the Bond Market, and we saw that on an annualized return basis stocks did best under Trump. They also did very well under Obama, decent under Biden, and horrible under George W. Bush. Bonds did best under Bush and worst under Biden. 

Now there are, you know, to assign credit or blame for this performance to the administrations is really you know, is problematic, because there are so many variables at play, and the broader context, of course, is really key to consider. 

Eden Alemayehu: With all of those variables at play like you said, how can investors prepare their portfolios in anticipation for this upcoming election? 

Dan Lefkovitz: Yeah, well, like, I said, I think making bets is really problematic for multiple levels. 

You know, I guess it's pretty boring advice. But and I'm not qualified to give actual advice. But you know, I'd say diversification is, you know, called the only free lunch, and investing for a reason and having all kinds of assets in your portfolio, stocks and bonds, maybe commodities and alternative strategies as well that are diversified across,you know, investment, style and size and geography and sector is really key. You want to have a portfolio that's really robust to a range of different scenarios. 

And maybe, Tom, maybe you can talk about, you know ,how you can do some scenario analysis based on historical data. 

Tom Nations: Yeah, I mean, well, first of all, I would just recommend everyone read the research that Dan did and put this together, because it really is exhaustive and thorough, and goes through all these past elections using Morningstar Indexes and Morningstar Direct to really underpin all the analysis. And, like you said, provide data driven analysis on this. You know it is really fantastic, I think. You know, the thing that I recommend is, you know, similar to what Dan said in terms of like, 

there's not a lot you can do necessarily to prepare your portfolio. Given the different policies, you know, we kind of generally know what the policies are of the two candidates for the most part, and the various parties. 

 But actually making portfolio tweaks, but based on that is kind of a different discussion. Now, what you can do is sort of the modeling of you know, what does a portfolio look like if let's say, for example, technology comes back a little bit. You know, it's been this high-flying industry. 

You know, what if it underperforms any other sector? You can do that sort of stress testing within Direct with our scenario analysis tool, within the risk model. So, there's that. I mean, Dan talked a lot about diversification, you know the only free lunch and investing. You know what you can look at for that is correlations, right? So, what have the correlations been of the various assets that I hold not just the asset classes, but the specific investments in my portfolio? What do they look like not only over the trailing year, trailing three years, but in different environments, like, if there's specific time periods I want to look at, because, you know, while the historical correlations hold over longer time periods, there obviously some variability in between, just like short term performance. Following elections is also different from the long-term performance. 

So, there's a ton of tools you can do. And when you, when you want to sort of find investments, if you have sort of an idea for adding that diverse diversification or playing a specific theme, uou know, you can do the diligence to find the right investments for your portfolio. But the key thing, you know, to understand is like, you know, what are the market expectations going into the elections, and am I prepared for, you know, if it moves in either way, right? And that's sort of what Direct can offer when you're looking at a portfolio or a list of funds, or whatever is being able to model out different changes in different environments without having the exact answer in your hand, because no one has the exact answer in your hand. 

For all the reasons Dan discussed in terms of the amount of factors that go into all the, you know, the markets, performance, and all the individual companies and funds that go into that. So that's what I'd say. 

Eden Alemayehu: Thanks, Dan and Tom, for all of your insights today. 

While elections can temporarily impact markets, it seems like a well-diversified and informed approach is essential for navigating these moments with Morningstar Direct. We have the research, data and tools to dive deeper and test portfolios against scenarios and benchmarks. 

So as election day comes closer, take a look at Morningstar Direct to see how our tools can help you prepare for the upcoming election and the year ahead. 

Thanks for listening.