Clear and present danger to sharemarkets posed by Republican presidencies

Historically, the best average returns from the S&P 500 occurred when a Democrat occupied the White House and Congress was divided. Picture: Getty Images

Immediately after Donald Trump’s election as the next president of the United States, market analysts began exploring historical correlations to assess potential implications for investors.

Despite the fact presidents are elected or re-elected every four years, and most investors operate on longer time horizons, the intersection of US political leadership and the performance of the S&P 500 is a compelling subject for those eager to find or promote shortcuts to investment success.

The popularity of the analysis is partly due to regular elections providing a competition and a starting point from which a wealth of data enables investors to identify patterns and correlations between political regimes and market performance.

An analysis of the S&P 500 index from 1950 to 2023 reveals notable trends related to the political composition of the US government.

Historically, the best average annualised returns from the S&P 500 (15.72 per cent) have occurred when a Democrat occupies the White House and Congress is divided – akin to a hung parliament here in Australia.

The winning combination may suggest that checks and balances between the executive and legislative branches creates a favourable environment for the economy and market performance.

To check that theory, you only need to calculate the average annual compounded return of having a Republican president and a dividend Congress. Historically, that scenario has produced an average yearly compounded return of 12.20 per cent.

By contrast, with the 2024 election producing a Republican president and a Republican-controlled Congress, historical patterns suggest that the next four years could coincide with lower average annual returns.

Accumulated historical data indicates that combination commencing in 2025 would produce an average annual compounded return of 11.70 per cent. Of course, none of this considers exogenous events such as financial crises, recessions, or geopolitical conflicts and wars.

I looked at the compounded average annual performance of the S&P 500 during each presidential term since Theodore Roosevelt. The data revealed three prominent findings.

First, there has been a roughly even split in presidential terms between the two major parties since Theodore Roosevelt, with 17 terms held by Democrats and 18 by Republicans. Note that a two-term president is counted as one term.

Second, all presidential terms that coincided with negative average annual returns in the S&P 500 occurred under Republican leadership. That’s something to think about over the next four years.

Finally, only once did a negative term follow another negative term. And notably, whenever a Democrat succeeded a negative Republican term, the S&P 500 consistently experienced favourable compounded average annual growth rates.

Putting all that aside, however, perhaps the most striking revelation is that every presidential term has witnessed a market drawdown — a peak-to-valley decline in the S&P 500 index. And except for three Democratic terms that experienced single-digit declines, all other terms experienced double-digit drawdowns. This underscores the inevitability of market corrections, regardless of who occupies the Oval Office.

The data reveals that drawdowns have been more severe under Republican presidents, and that the average of the double-digit drawdowns has been a 32.6 per cent decline; the smallest of the double-digit drawdowns was 13 per cent and the largest drawdown 86 per cent, admittedly during the Great Depression.

Excluding that 86 per cent drawdown associated with the Great Depression, the average Republican S&P 500 drawdown is significant at 29.5 per cent. By contrast, under Democratic presidents the average of the double-digit drawdowns was 24 per cent and the largest drawdown was 54 per cent.

These figures suggest that under Trump’s leadership, investors might reasonably anticipate not only a drawdown but a double-digit one that could be more severe than if a Democrat were seated in the Oval Office. Single-digit drawdowns appear unlikely in this context.

History suggests that while a significant drawdown is likely, its exact magnitude can’t be determined but several conclusions do emerge.

First, with a Republican at the helm, it is almost certain that a market drawdown will occur within the next four years. Second, the probability is high that the drawdown will be in double digits. Third, historically, drawdowns under Republican presidents have been more severe than those under Democrats.

A compelling discussion arises on the subject of whether Republicans cause market corrections or whether their election in the first place reflects underlying socio-economic factors that also lead to market downturns.

While it’s impossible to predict market sell-offs with certainty, considering current potential catalysts can provide valuable context.

An assertive China under President Xi Jinping poses significant geopolitical risks. We have already heard intelligence agencies report that Xi has directed the People’s Liberation Army to be prepared for a potential invasion of Taiwan by 2027. Meanwhile, military strategists believe the PLA will be ready by then.

Elsewhere, the substantial debts accumulated during periods of ultra-low and zero interest rates are now approaching maturity, creating potential liquidity strains.

Michael Howell of Crossborder Capital highlighted this issue in October, when he wrote that “if bull markets always climb a wall of worry, then financial crises often smash into a wall of debt … Next year and particularly 2026 will prove challenging years for investors”.

These debt refinancing challenges could act as a catalyst for market corrections, particularly if liquidity becomes constrained.

Historical data provides insights but does not dictate future outcomes

Nevertheless, while history may not repeat exactly, it often rhymes. Investors should prepare for the possibility of market corrections during the Trump administration but avoid making decisions based solely on historical correlations. By focusing on fundamental analysis and maintaining a long-term perspective, investors can navigate the potential volatility and come out wealthier when the next president replaces Trump.

Roger Montgomery is founder and CIO at Montgomery Investment Management