General elections have an impact on stock markets. Uncertainty about the outcome typically leads to increased market volatility before the vote, and markets continue to adjust after the election as the policy priorities of the new administration become clear.
A clear margin of victory and the return of an incumbent president tend to reduce uncertainty and minimize the volatility observed in the stock market.
Accurately predicting the outcome of an election is difficult. Over the past decade, pollsters, political analysts, and reporters have made some notable prediction errors. One clear example is the 2016 US presidential election, where Hillary Clinton was estimated to have a 71% to 99% chance of winning (Kennedy et al., 2018).
Financial markets reflect this challenge: when there is no clear agreement on the election outcome, daily price fluctuations tend to be larger and offset each other. This amplifies market volatility during election periods, while keeping overall prices constant.
The magnitude of the volatility also depends on the electoral system. Majoritarian systems, such as the UK’s “single-member district” or the US’s Electoral College, where losing by 0.5% has the same outcome as losing by 95%, are less predictable than proportional representation systems. This can have a significant impact on stock market returns (Lausegger, 2021).
This difficulty is manifested in increased stock price volatility during election periods: one study found that in the 51 days before and after an election, stock market returns were more than 20% more volatile than expected. Moreover, the costs of taking this risk are relatively modest (Bialkowski et al., 2008).
Why does the stock market care?
The connection between elections and the economy has long been known: studies from the 1970s noted that politicians often stimulate the economy before elections to gain support, and then implement tough measures afterward, such as raising interest rates to curb inflation (Nordhaus, 1975).
This may explain some of the long-term predictability in the U.S. stock market: studies of how stock markets process information during election cycles suggest that the market was somewhat inefficient because some long-term trends were predictable (Allvine and O’Neill, 1980).
The study proposed a trading strategy that involves buying stocks two years before a US presidential election and selling them just before the election. This strategy outperformed a “buy and hold” strategy by 3.4% per year from 1961 to 1978. Subsequent studies updated the data to include the early 1990s and found similar results (Gärtner and Wellershoff, 1995).
There is some evidence to suggest that it is not just the timing of elections that influences the stock market, but also the outcome of elections. Contrary to the assumption that Wall Street prefers Republican presidents, evidence shows that stock markets historically perform better under Democratic presidents (Santa-Clara and Valkanov, 2003)..
Other studies highlight that the reaction of a particular stock to the election outcome depends on the tax policies that may affect the company and the industry in which it operates (Wagner et al, 2018).
What about the UK?
[From1945to1994onlyoneofsixLabourvictoriesproducedapositivechangeintheFT30indexofBritain’slargestcompaniesthenextdaycomparedwithsevenofeightConservativevictories(Hudsonetal1998)ThissupportsanecdotalevidencethattheCityprefersConservativegovernments[1945年から1994年まで、労働党が勝利した6回のうち、翌日の英国最大手企業のFT30指数にプラスの変化をもたらしたのがわずか1回だったのに対し、保守党が勝利した8回のうち7回はプラスの変化をもたらした（Hudsonetal、1998）。これは、シティが保守党政権を好むという逸話的な証拠を裏付けている。
However, over the long term, the analysis shows that there is no difference in UK stock market returns under Labour and Conservative governments. Trading strategies that seek to take advantage of predictable returns in the two years before an election are also found to be ineffective in the UK. This suggests that the outcome of a general election may have less of an impact on long-term market returns in the UK than in the US.
Figure 1: UK stock market performance by government, 1923-2017
Source: Bank of England Millennium Economic Data, author’s calculations
Figure 1 seems to support the idea that markets perform better under Conservative governments. Using 1000 years of economic data from the Bank of England, we extend our analysis from the 1920s, when the first Labour government came to power, to the end of the database in 2017, and find that the Conservative governments of 1979-1997 and 1951-1964 coincided with periods of robust stock market growth of over 36% and 22%, respectively. Most Labour governments saw little stock market growth.
However, Conservative (or Conservative-controlled) governments in the 1920s, 1930s, 1970s and 2010s saw share price indexes grow by just 1% to 5% over their parliaments. By comparison, under the Labour governments of 1974-1979, share prices grew by over 28%. This suggests that any long-term correlation may be more coincidence than causation.
Part of the market’s perception of a Conservative government may be due to the party’s bigger victories in general elections and its ability to stay in power longer than Labour.
Figure 1 shows that the adage “being in the market for a long time is more important than timing the market” is more strongly supported by the Conservative government’s length of power of 679 months compared to 398 months for Labour governments. This means that the average length of Conservative government is 84 months and the longest government is 216 months compared to 66 and 156 months for Labour respectively.
Is there no effect?
While there may be no evidence that election results have a long-term effect on the stock market, the same is not true in the short term. Short-term effects of national elections have been found in several studies.
One cross-national analysis found that stock market volatility can double during election weeks, due to a combination of factors including close elections, narrow wins (which lead to even greater volatility in coalition governments), and changes in government (Bialkowski et al., 2008).
Another international study covering the period 1974-1995 found positive abnormal returns two weeks before election weeks, especially when elections were decided early and the incumbent government was defeated (Pantzalis et al, 2000).
Short-term effects are more severe when the outcome is uncertain and delayed, such as the 2000 US presidential election. These cases are typically associated with negative stock market reactions (Nippani and Medlin, 2002). Short-term effects also tend to be more pronounced in the case of unexpected election outcomes, such as the 2016 US election results (Wagner et al., 2018).
This year, the impact of the UK general election may be exacerbated by the impact of the US presidential election in November. There is evidence that the US political cycle may be a proxy for global political uncertainty (Brogaard et al., 2020). US election periods tend to suppress non-US equity returns and increase volatility as investors become more risk averse and invest in less volatile assets.
Do policies affect stock prices?
There is political uncertainty before elections. This uncertainty has a direct impact on the real economy, which can be reflected in stock market valuations. US data shows that companies reduce investment spending by about 5% in election years (Julio and Yook, 2012).. Furthermore, political risk affects the value of international investment in a country (Bekaert et al, 2014).
After the election, political uncertainty is likely to be replaced by policy uncertainty as the priorities of the new administration become clear. Unlike the intended effects of economic policies, stock markets react negatively to economic policy uncertainty.
A study using over 100 years of data found that increased economic policy uncertainty increases risk and suppresses stock returns for companies and industries that are particularly sensitive to government spending and regulation, including sectors such as defense, healthcare, and finance ( Baker et al., 2016 ).
The negative impact on stock markets is most likely due to economic policy uncertainty spilling over into the real economy, with investment, industrial production and unemployment all reacting negatively.
Regime change is often associated with shifts in foreign policy and international relations. Geopolitical risk shocks are also associated with declines in stock prices (Caldara and Iacoviello, 2022).
With the UK elections coming up in July and the US elections in November, investors should expect market volatility.
Where can I find more information?
Who are the experts on this issue?
- John Turner
- Gareth Campbell
- Eloy Dimson
