How Do Elections Affect Bond Market Returns?
Election outcomes have had a distinct affect on bond market returns throughout recent history, but with the United States’ debt load now surpassing $16 trillion, it remains to be seen whether this year’s election can have a meaningful impact on bond yields.
Why do elections matter for the bond market? Very simply, investors react favorably to policies that are seen as being fiscally responsible – i.e., that reduce debt rather than add to it. As a result, the prospect of lower spending, and in some cases higher taxes, can be very favorable for the bond market. Since Republicans traditionally have been seen as being more likely to reduce spending than Democrats, Republican control has typically created a more favorable backdrop for bonds.
A 2006 study in the Financial Services Review titled, “Tactical Asset Allocation and Presidential Elections” reported that from 1961 through 2004, long-term government bonds produced an average annual return of 4.14% when a Democrat was in the White House and 10.80% when a Republican was in control. The average annual return for the full period was 7.77%. This gap has since closed, however, as long-term government bonds have performed very well since President Obama was elected in 2008.
It’s not just the executive branch that matters when it comes to the bond market – the political leanings of Congress also play a role. A prime example of how Congress also can affect rates occurred during Bill Clinton’s first four years in office. In the time of President Clinton’s election (November 3, 1992) through the subsequent mid-term election (November 8, 1994), Democrats controlled both the executive and legislative branches. The yield on the 10-year U.S. Treasury note climbed from 6.87% to 8.01% during this interval. But halfway through Clinton’s first term, Republicans rolled to a surprisingly large victory in the 1994 mid-term Congressional elections. Investors, cheered by the prospect of increased fiscal discipline, reacted by buying Treasuries. Two years later, in November 1996, the 10-year stood substantially lower at 6.36%. (Falling yields indicate rising prices.)
Immediately after elections, however, the results are somewhat different. On October 15, 2012, Bloomberg reported that since 1964 yields on 10-year Treasuries have dropped about 0.40 percentage points in the first month after the election when a Democrat wins, and risen 0.19 percentage points following a Republican victory. It should be noted that these numbers are skewed by the large drop that followed President Obama's victory in 2008, when rates were plunging amid the depths of the financial crisis. Bloomberg also reports that since 1964, yields have averaged 5.74% under Democrats and 7.46% while Republicans occupied the Oval Office. The full article is available here.
Elections and Corporate Bonds
The political environment also has an impact on corporate bonds. A 2004 study conducted by the asset management firm Dimensional Fund Advisors (DFA) showed that corporate bonds perform best relative to Treasuries in the months immediately surrounding the election. In the period from 1928-2000, corporates outperformed in the August and September prior to the election, underperformed slightly in October and November, then outperformed once again in December and January. The two best months of relative performance were the January after the election, followed by the August before. The positive effect on corporates gradually dissipates following the February after the election, and disappears entirely by April. According to the study, corporate bonds’ relative performance is much stronger in the years when the incumbent is not re-elected.
The Bottom Line
Ultimately, individual investors should construct their bond portfolios based on their own individual needs rather than reacting to news events. So keep an eye on the political headlines, but don’t use it as a basis for portfolio construction.