cfainstitute:
By Lauren Foster
“I think that you will all agree that we are living in most interesting times. (Hear, hear.) I never remember myself a time in which our history was so full, in which day by day brought us new objects of interest, and, let me say also, new objects for anxiety. (Hear, hear.)” — Joseph Chamberlain, 1898
Few would dispute we live in interesting and anxious times.
Hillary Rodham Clinton made history when she became the first woman presidential nominee of a major US political party. All eyes are now on the 8 November election when voters will head to the polls to cast their ballots, whether for Clinton, her Republican opponent Donald Trump, or any of the myriad third-party challengers, thus deciding who will be the 45th president of the United States.
Despite the euphoria in the Clinton and Trump camps, there remains a great deal of uncertainty about the outcome of this election and what it will mean for the United States and the country’s standing on the world stage.
This uncertainty extends to the effect of US elections on stock prices, judging by the voluminous and often contradictory research on the topic.
“Historically, whether a Republican or Democrat occupies the White House has had no statistically significant impact on US equity markets,” writes Russ Koesterich, CFA, head of asset allocation for BlackRock’s global allocation team. “Presidential election years generally have coincided with favorable markets, particularly when the incumbent party wins,” says T. Rowe Price. In a 2008 blog posted titled “Presidential Elections and the Stock Market,” Pete Davis concluded that “most of the studies show quite an advantage for equities following the election of Democrats, but a Federal Reserve study concludes there is no consistent relationship if you correct for market volatility and test back to 1852.”
The most frequently cited paper, according to Davis, is a 2003 article in the Journal of Finance by Pedro Santa-Clara, professor of finance at the Nova School of Business and Economics, and Rossen I. Valkanov, professor of finance at the Rady School of Management at UC San Diego. Davis noted:
“[The authors] found 9% higher stock market gains for large stocks in Democratic administrations since 1928. However, Santa-Clara and Valkanov did not correct for swings in market volatility or examine periods before the Depression, when market volatility was lower. In a 2004 paper, two Federal Reserve economists, Sean Campbell and Canlin Li, made those corrections and found that the 9% higher return dropped to 4%. They concluded that market returns don’t track with which party wins presidential elections.”
A 2012 article, “How Political Conventions Affect Stocks,” noted that “in the 16 presidential election years since 1948, the S&P 500 rose during 11 Republican conventions (as measured from the start to the end of the convention), according to a report by S&P Capital IQ. In contrast, stocks made gains during only seven Democratic conventions.”
Below is a list of additional articles that examine the link between US presidential elections (and administrations), the economy, and stock market performance. (Note: We first published this list in 2012, but have recently updated it.)
Do Election Cycles Sway the Markets?
William Watts, MarketWatch’s senior markets writer, examined what Deutsche Bank and S&P Capital IQ had to say about the presidential election cycle and the outlook for 2016. His conclusion? “In the end, how stocks perform in an election year might have less to do with the candidates than the economic backdrop that will frame the battle.” (MarketWatch, December 2015)
In “7 Fascinating Facts About How US Presidents Affect The Stock Markets,” editor Sam Ro briefly annotates several oft-repeated statements such as: “the third year of a President’s term is usually the best for stocks” and “since 1900, only five presidents have seen stocks rise more than 50% during their term.” (Business Insider, March 2012)
A survey of US members conducted by CFA Institute posed this simple question: Will the outcome of [next month’s] US presidential election have any impact on economic recovery in the United States in the next year? A larger-than-expected 80% of survey respondents said that it would have an important impact on the economy going forward. Good news for people hoping something, anything really, gets going in Washington to remedy our economic malaise. (Market Integrity Insights, October 2012)
In this podcast, Robert Stammers, CFA, talked to Michael Gayed, CFA, a co-portfolio manager at Pension Partners, to get a sense of what might happen after the 2012 election. Gayed often comments on the effect of macroeconomic trends on the capital markets. (Inside Investing, October 2012)
“The last seven months of an election year almost always boost stockholders’ portfolios, with the market having delivered positive returns for S&P 500 stockholders in all but two election years since 1952,” according to “Presidential Elections are Good for Stocks, But …” (Christian Science Monitor, February 2012)
In a client note, Goldman Sachs offers “3 Reasons Why Investors Should Take US Election Cycles Very Seriously.” “First, the political stakes in presidential, parliamentary, or legislative elections often translate into changes in policies that can reshape the economic environment. Second, the regularity with which elections take place in most countries may give place to cyclical patterns in government and investment behavior. And third, elections can markedly increase political and social uncertainty. These three factors have the potential to affect all asset classes, especially equities, given their strong sensitivity to changes in the economic outlook.” (Business Insider, February 2012)
In “Electoral Maths: Presidential Elections and the S&P 500,” FT editor John McDermott addresses the performance of US equities in past election years and the implications for 2012. (FT Alphaville, December 2011)
Back in 2010 — two years into President Obama’s term — Jeremy Grantham, the chief investment strategist at GMO, noted that despite precarious economic growth and the fact that stocks weren’t all that cheap, in the near term, there was a good chance that the market would rally. Why? Because at the time, the US was “entering the sweet spot of the presidential election cycle” and “it’s very hard to bet against it.” As the reporter noted in “A Presidential Reason to Buy Stocks,” “a cottage industry has sifted the data going back more than a century and found that the stock market has generally done much better in the second half of a president’s four-year term than in the first.” (The New York Times, October 2010)
In “The Presidential Term: Is the Third Year the Charm?” the authors respond with a decisive yes, noting that their research shows “equities have generally prospered in the second half of a president’s term and especially during the third year.” (Journal of Portfolio Management, Winter 2008)
But in a radio interview, Rodney N. Sullivan, CFA, then head of publications at CFA Institute and editor of the Financial Analysts Journal, told listeners that while it is “indeed true that under years three and four of a presidential cycle stock markets tend to do better,” the data have been “misused or abused.” He offered two powerful counterexamples: “In 1933, during President Franklin D. Roosevelt’s very first year, stocks rose more than 50%. Under President Herbert Hoover’s third year, stocks fell almost 50%. What really drives performance in market is not the presidential cycle, it’s really the overall macroeconomy,” Sullivan said. (Enterprising Investor, 2012)
The authors of the 2008 paper “Financial Astrology: Mapping the Presidential Election Cycle in U.S. Stock Markets” examined nearly four decades of stock returns and found that “U.S. stock prices closely followed the four-year presidential election cycle. Stock prices generally fell during the first half of a Presidency, reaching a trough in the second year, and rose during the second half of a presidency, reaching a peak in the third or fourth year.” (Social Science Research Network, October 2008)
Does the Stock Market Pick the President?
Tom McClellan, technical analyst and editor of the newsletter The McClellan Market Report, says: “If the market moves up, that tends to benefit the incumbent in the last elections. If the market bids up people tend to feel better about it, and if people are feeling good they like the guy who’s in office more.” (In this model, the market views Hillary Clinton as the incumbent.) Conversely, “If you see the market head downward, which I’m expecting after a top in early July, that would presumably go in [Donald] Trump’s favor.” (Yahoo! Finance, June 2016)
“InvesTech Research of Montana says the stock market is the most reliable indicator of who will win the presidency and has been for more than 100 years,” according to “Stock Market Picks 90 Percent of Presidential Elections.” In other words, “the election is a reaction to the stock market.” (US News & World Report, February 2012)
Does It Matter Who Wins the Election?
“To what extent does the stock price change immediately after a presidential election relate to or predict the presidential administration’ economic performance as defined by GDP growth and unemployment?” In “Stock Market, Economic Performance, and Presidential Elections,” the authors use stock market and economic data from more than a century to examine the relationships between post-Election Day market return and economic performance during the presidential term. The researchers found that after-election market movement has become increasingly more accurate in predicting future GDP growth, but not future unemployment rates. (Journal of Business & Economics Research, Second Quarter 2014)
Morgan Housel believes the clearest way to get a sense of how the economy has performed under past presidents is to look at five economic variables going back to 1900, covering every president from Teddy Roosevelt to Barack Obama: (1) stock market performance; (2) corporate profits; (3) real GDP per capita; (4) inflation; (5) the unemployment rate. (The Motley Fool, October 2012)
Ron Rimkus, CFA, believes it is a fool’s game to try and tie presidents and election cycles to stock market returns. In a blog post, “Elections and Stock Prices: Assessing the Impact Is an Exercise in Futility,” he writes: “Oftentimes, we hear pundits ask: What US presidents were good for the stock market? How did the markets respond to a particular president? Or what political party has had more success in the markets? All of these questions are doomed to failure. Is it not possible for a president of one party to enact a policy typically favored by another party?” Rimkus notes that “most academic work ignores the vast differences and underlying nature of specific policies. So, the whole exercise of using statistical analysis to claim one party is better for the stock market than another is merely an exercise in … you guessed it … politics.” (Enterprising Investor, 2012)
Bloomberg News asserts that “Stocks Return More With Democrat in White House” based on the fact that the BGOV Barometer from Bloomberg Government showed that “over the five decades since John F. Kennedy was inaugurated, $1,000 invested in a hypothetical fund tracking the S&P 500 only when Democrats were in the White House would have been worth $10,920” at the close of trading on 21 February 2012 (the day before the article ran). “A $1,000 stake invested in a fund that followed the S&P 500 under Republican presidents, starting with Richard M. Nixon, would have grown to $2,087 on the day that George W. Bush left office.” (Bloomberg News, February 2012)
“The Market and Presidential Promises” is a handy primer on presidential election cycle theory, which was developed by Yale Hirsch (creator of the Stock Trader’s Almanac) and is based on historical observations that the stock market follows, on average, a four-year pattern that corresponds to the four-year election cycle. For another take on how politics can affect the stock market, see “For Higher Stock Returns, Vote Republican Or Democrat?” (Investopedia, September 2011 and October 2010, respectively)
A 2011 paper, “Resolving the Presidential Puzzle,” explores whether “there is a risk-based explanation for higher returns during Democratic presidencies compared with Republican presidencies. Their findings show that the market exhibits higher returns when Democrats control the presidency, with smaller companies experiencing the most significant improvement.” (CFA Digest, Summer 2011)
Have you seen any interesting articles on how the presidential elections affect stock market performance? Share the links below.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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