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Election Day will be here before we know it meaning all that pre-election conjecture about how results will affect various asset classes will either be validated or prove erroneous. The imminent arrival of the 2024 election also implies is now an ideal to consider what works after the polls close and markets begin digesting the results.
In the world of equities, it might surprise some investors to learn that small-caps have historically performed well following presidential elections. This is not an endorsement of a particular candidate or party, but data confirm small-cap equities delivered for investors following the 2016 election. A big reason why was the tax cuts pushed forth by then President Trump and congressional Republicans.
That phenomenon is easily explained. Many small-cap companies aren’t profitable so tax savings are a boon. Additionally, smaller firms often lack avenues for mitigating tax exposure, meaning they can be subject to the highest effective rates.
Obviously, 2016 is just one example so it’s worth examining if the trend of small-caps being post-election winners proves durable over time. It has, particularly when the right strategy is deployed.
Examining EES Post-Election Excellence
“Right” is often subjective in investing, but when it comes to small-cap exposure, the WisdomTree U.S. SmallCap Fund (EES) has been a long-term winner. That exchange traded fund launched in February 2007, so this year will be the fifth presidential election year since EES debuted. Over the past three, five and 10 years, EES bested the Russell 2000 Index and as the chart below indicates, the WisdomTree ETF has been a winner in mid-term and presidential election years.
Chart Courtesy: WisdomTree
Alright, so skeptics might assert, and accurately so, that EES’s impressive post-election performances in 2016 and 2020 were facilitated by tax cuts (2016) and markets rebounding from the brief coronavirus bear market (2020). Still, as the above chart confirms, the ETF has proven durable across mid-term and presidential elections with a variety of outcomes.
The “secret sauce” possessed by EES that allows it to thrive regardless of election outcomes is its earnings-weighted methodology. Translation: the ETF’s index weighs components by earnings meaning they must be profitable to enter the index and the ETF. It’s hard to find that selectivity in the world of small-cap ETFs.
Gridlock Could Help EES
Two notes of pre-election caution regarding EES and any other ETF for that matter. First, the presidential race is going to be a nail-biter. Second, past performance isn’t a guarantee of future returns.
As for how things could shape for stocks in general, including small-caps, after Election Day, the increasing prospect of a divided Congress could be helpful. The political chattering class is speculating that the Democrats could win the House with the Republicans controlling the Senate. Gridlock prevents controversial legislation and that could be to the liking of small-caps.
“Now, even with all of that said, as divided as the rhetoric may sound as we approach the 2024 U.S. election, if history has been any guide, it has been a losing proposition, for the most part, to bet against U.S. equity markets,” notes Christopher Gannatti, WisdomTree global head of research. “There are never guarantees as to what we may see, return-wise, but we’d remind people that, frequently, the most likely outcome is a divided government where much of the current policy simply continues along.”
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