In Election Season, the Stock Market Can Be Fickle. So Be Patient.

The stock market has not only recovered from its tantrum of early August, it is behaving as if that downturn never happened.

Stocks have been rallying joyfully. With the political conventions behind us and the Federal Reserve expected to trim interest rates next month, many Wall Street strategists have reined in their nervousness about a possible recession and are betting instead on good times to come.

There are compelling reasons for the bullishness. Inflation has been subdued, and data on retail sales and jobless claims suggested that the economy remains in good health. Corporate earnings — which fuel the market — have been outstanding. Executives in earnings calls with Wall Street analysts say they are cautiously optimistic, both about the economy and their companies’ abilities to continue reaping profits.

Fed officials are meeting at Jackson Hole in Wyoming for their annual, informal conclave on the economy, but the markets are focused on the next formal policymaking session in Washington in September. The Fed is expected then to begin cutting interest rates, which have stood at 5.25% to 5.5% since July 2023. Lower rates are typically ambrosia for market traders.

What’s more, as the year goes on, the political calendar may become more favorable for the stock market, which has been largely indifferent to the twists in the presidential race so far. Historically, regardless of who wins or loses, the market has tended to rally once the outcome of an election seems a sure thing.

In essence, there are plausible arguments for why the market will continue to head higher. Yet I’m not jumping onto this bandwagon — or embracing any strong view on where stocks are going.

Just as it would have been a mistake to have abandoned stocks when they began to plummet in a short-lived wave of panic in Japan and then the United States early this month, it would be unwise to become too giddy about the market’s prospects now.

Financial markets are fickle. Over the long run, the stock market tends to rise because the arc of the economy and the ability of corporations to extract profits both trend upward. But you can count on facing sharp economic and market declines at unpredictable moments. Buying stocks with the expectation of making quick money is risky.

Most investing requires patience. It helps to navigate with as long a horizon as you can manage, backed by a well-diversified, low-cost portfolio that minimizes your risks and a healthy appreciation for history.

The Lurking Bear

The bullish case for the stock market is only half the story. It’s just as easy to cite arguments for being a bear.

The political season could cause a great deal of trouble for investors. With former President Donald Trump still denying that he lost the last election, it’s quite possible that clarity about the result of this one won’t be available until well after Election Day. While investors wait for a definitive picture, prolonged political uncertainty could heighten volatility.

Acute political strife, including violence like the attack on the Capitol of Jan. 6, 2021, would create drastic problems well beyond financial markets. But, if the national elections make you nervous, holding a sizable dollop of safe liquid assets such as cash and Treasury bills might give you the strength to ride out the turmoil.

For the stock market itself, the most important fundamental problem may be that prices are high, on a historical basis. This is true whether you look at the relationship between stock earnings and bond yields, at the standard price-to-earnings ratio or at the 10-year price-to-earnings ratio (called the CAPE) devised by economist Robert Shiller.

These metrics all show that investors aren’t getting much for their money — not when prices are compared with the average levels of the past, at least.

That cautionary note isn’t useful for short-term trading: The market can rise for years, even when prices look high, and it can fall when stocks seem cheap.

But over horizons of a decade or more, stock valuations have some predictive power, Shiller, who won a Nobel Prize for his research, has found. Today’s high prices imply that the outlook is cloudier than usual for U.S. stocks in the decade ahead — which is a reason to diversify by holding stocks in markets around the world. I do this through low-cost index funds, and take a global approach for bonds, as well.

It’s worth remembering that any number of factors can drive the market down. If fresh reports on inflation or unemployment in the United States move in the wrong direction, watch out. But that’s just a starter. Here are a few other potential issues:

• Stocks in Japan — or anywhere else — could drop sharply because of idiosyncratic factors, yet spark another global panic.
• Greater conflict could break out in the Middle East, Eastern Europe, East Asia or another region, setting off concerns about energy prices, shipping lanes and, far worse, the threat of world war.
• Disappointing earnings from an important tech company, like Nvidia (which reports next week), could shatter the Wall Street consensus that artificial intelligence will generate boundless profits.

I’m not predicting dire outcomes, just observing that risks abound.

The Long View

Surmounting worries like these is critically important, because the historical record shows that sustained, low-cost, diversified investing in stocks has worked out splendidly. Look at the returns of the humble Vanguard S&P 500 index fund. From July 31, 1980, through Monday, it returned 11%, annualized, according to FactSet. Cumulatively, that comes to 9,890%, which means that if you had put $1,000 into this plain vanilla fund back then and reinvested all the dividends and just held on, you would have almost $99,900 now.

Achieving those gaudy numbers required decades of patience, and the ability to withstand wrenching shifts in market values. Of course, if you had bought and sold at the right moments, you could have done better than this, but the vast majority of people did the opposite. Buying shares of broad index funds and holding them for decades has been a better strategy for most people, many studies show.

But let’s say your horizon is short. Perhaps you need to use your money or just don’t have the psychological resources to buy and hold index funds for decades. Over the past 100 years, how long would investors have needed to keep their money in the U.S. stock market to avoid any losses?

Morningstar Direct, a unit of the independent financial services company Morningstar, crunched the numbers for me, examining stock and bond performance in every calendar year from 1926 through 2024. It found that you needed to have held a pure, broad stock investment for more than 15 calendar years. If you were diversified and held long-term Treasury bonds in addition to stock, you needed a decade to ensure you had no market losses.

The Morningstar Direct calculations also showed that over five-year periods, you would have had losses in fewer than 10% of those stretches if you held at least 10% of your portfolio in bonds.

Losses were more common over one-year periods: They happened 30% of the time if you held only stock and 18% of the time if 60% of your portfolio contained bonds. Other mixtures were less prone to losses than the pure stock portfolio but riskier, in that sense, than the portfolio that was 60% bonds.

Prudent Steps

So, if believe you will need to use some of your invested money over the next five or 10 years, you might conclude from this that you should hold a large proportion of high-quality bonds.

Here’s another sobering thought: Other stock markets have needed much longer than 20-year periods to recover from losses. Take Japan. It was only in February that the Japanese market recovered from a decline that started in December 1989, more than 34 years earlier. The Japanese experience won’t be duplicated exactly in the United States, but protracted losses could happen.

Then there’s the erosion in stock values caused by inflation. Include that effect, and the U.S. numbers look much worse. Shiller makes inflation-adjusted U.S. stock data available on his website. Using inflation-adjusted dollars, you will see that it took 29 years to recover from the stock market crash of 1929.

The historical record is a precious resource but doesn’t tell us what this or any country will be like in the future. I’m pleased that the markets have been calm lately and that the Fed is hinting that interest rate relief will be coming.

But don’t simply assume that the markets or the economy will be fine. Hedge your bets, and be prepared.