What 401(k) and IRA moves to make before a nail-biter presidential election like Trump vs. Harris

By Brett Arends

There is a lot of fear - on both sides

Keep some cash on the sidelines in your 401(k) or IRA as we head into the presidential election, and if the market sells off over the next few weeks, seize the chance to throw that money into a small-cap U.S. stock fund.

This looks like a smart game plan, at least based on some new research from well-known Wall Street guru Rob Arnott, the chair of investment company Research Affiliates, and his colleague Forrest Henslee.

But it might be easier, and possibly better, to simply resolve not to panic about the election, regardless of your politics, and to hang on to your stock funds no matter what happens.

This year's presidential election isn't just close, it's a nail-biter. Most commentators think it's a toss-up as to whether Kamala Harris or Donald Trump will win, and the result may well come down to a small number of swing voters in Wisconsin and Pennsylvania.

Read: Yes, you need to brace your portfolio for a possible Trump win

In a new paper, Arnott and Henslee have run the numbers on close U.S. presidential elections going back to the 1920s. They've found a strong pattern: Historically, when the election result has been in doubt, markets have been volatile in the final month before polling day. This has ended about a week before election day, when stock prices have suddenly started rising. This rally has continued in the weeks after the election, regardless of which party won, they report. And small-cap stocks have done considerably better after the election than shares of larger companies.

"Stocks tend to fall in the run-up to a close election, then surge in the final week of the campaign before continuing their upswing, albeit with greater volatility, post-Election Day," they write. "Following a close election, small-cap stocks have historically outperformed large-cap stocks by about 2.5% over the next 30 trading days."

There are good reasons this might be the case. As we have all seen, during presidential elections large numbers of people seem to become unmoored from reality. They become convinced that if the other guy wins, the world will soon go to hell in a handcart. When an election result is in doubt, this means you have two groups of people panicking - Democrats and Republicans.

When that happens, some of them dump their stocks in fear, driving down the market.

After the election, the fever seems to break. People on the winning side are more cheerful. People on the losing side realize the world hasn't ended. And so lots of people go from "risk-off" to "risk-on."

"We believe this is due to fear of the outcome increasing (on both sides of the aisle) ahead of the election and then dissipating (on one side of the aisle)," Arnott and Henslee write.

It's a plausible argument, though admittedly their analysis is based on a smallish sample of eight nail-biters: 1948, 1960, 1968, 1976, 2000, 2004, 2016 and 2020. The results, they add, nonetheless seem "statistically robust."

Why would the rally start a week before the election? Possibly because Wall Street is neither blue nor red - instead, it's green. Traders can see what's about to happen, and they buy stocks cheaply in anticipation.

Arnott recalls his experience during the close 2004 election campaign between John Kerry and George W. Bush. "A billionaire client who was a major Democratic donor was so panicked that President George W. Bush might secure a second term during the 2004 election campaign that he wanted to liquidate his stockholdings just in case Bush won," he recalls. Arnott his colleagues managed to dissuade the client. "We explained that people on both sides of the political divide had similar inclinations and would go risk-off lest their side lose. After the election, the half of the electorate that welcomed the outcome would go risk-on. We encouraged him to defer his decision at least until a few weeks after the polls closed."

The client agreed. Bush won, the market rose and the client forgot all about the world ending.

Before the 2016 election, I reckoned Trump had a much better chance of winning than the polls suggested, and I thought this might produce an immediate stock-market shock - just as the Brexit vote in the U.K. had done a few months earlier. I was right about the first part but not about the second. Or more accurately, the stock-market shock was so quick that if you blinked, you missed it.

The ingredients are certainly in place this time around. Donald Trump calls Kamala Harris a Marxist and a far-left loon. Marxists, let it be said, probably aren't good for the stock market, so presumably MAGA Republicans are selling their stocks in case Harris wins. Meanwhile Democrats are calling Trump a fascist, a threat to democracy and a would-be dictator. Presumably they, too, will be reluctant to commit themselves too heavily to stocks. Especially when Trump's own running mate, J.D. Vance, is breaking protocol and warning of a possible financial crisis if his own side wins.

The stock market so far has been dominated by the Federal Reserve and by China's latest attempts to turn around its ailing economy. Whether it will be dominated by the election over the next month remains to be seen.

As Arnott and Henslee point out, despite all the pre-election talk, it rarely makes much difference to the stock market whether the country elects a Republican or a Democrat as president. Superficially, when you compare the numbers since the 1920s, Democratic presidents have overseen higher average annual stock-market returns than Republicans, but those averages are heavily skewed by the crash of 1929 and the financial crisis of 2008, both of which happened on Republicans' watches. A sample of two is not a reliable guide. Take those out and the figures are about equal, they say.

(A small sample suggests that when Republicans have won the White House as well as the House of Representatives and the Senate, the stock market has done really well.)

They add that the picture is much the same in other comparable countries, such as Canada, Australia, France, Germany and the U.K. There is no clear difference between the market reaction to liberal and conservative election victories.

Small-cap stocks, as measured by the Russell 2000 RUT or the more selective S&P 600 SML indexes, have trailed the large-cap S&P 500 SPX so far this year. They are now at or near their lowest levels compared with large caps in at least 20 years. If you figure such things are cyclical, this suggests that sooner or later we are likely to see them outperform large caps.

The Russell 2000 has beaten the large-cap S&P 500 in only two of the past 10 years: the election years of 2016 and 2020. Will we see it again? Stay tuned.

-Brett Arends

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09-25-24 1455ET

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