Download MARKETWATCH: PRESIDENTIAL ELECTIONS: DO THEY AFFECT

MARKETWATCH: PRESIDENTIAL ELECTIONS: DO THEY AFFECT THE PERFORMANCE OF
THE ECONOMY OR FINANCIAL MARKETS?
Andrew Baron, CFA, Chief Investment Officer, Butterfield
The Cayman Islands Journal, 4 May 2016: Elections are, by their nature, uncertain which is why
they are held in the first place. If the US was a homogenous society and a place of easy consensus,
it would be quite straightforward to elect a President, even in a country of 300 million people. It
may appear that this election year has a larger degree of uncertainty and bears little resemblance
to past elections, but it might do to remind readers that in 2008, Barack Obama was a rank outsider
at the beginning of the nomination process. The country still wound up electing both its first
African American President, as well as one with much more progressive agenda than had been
popular for decades. The one thing we can reliably count on is the likelihood that the pundits and
pollsters will get it wrong! In that way, political punditry bears a striking similarity to financial
market punditry.
So does the 2016 election matter to your portfolio? Is there a discernible link between the results
(or predictions) of presidential elections and the economy? Further, is there a link between which
party occupies the White House and financial market returns? In order to answer these questions–
several academic studies and statistical surveys have tried–there is first the question of “belief”.
Americans, perhaps all citizens living in democratic nations, have an inherent bias toward believing
that their choice of political representative actually has some tangible effect on their lives.
Financial market professionals are, of course, not immune to this phenomenon. A 2012 election
year survey by the CFA Institute of its US members found that 80% of respondents believed that the
outcome of the election would have an important effect either positive or negative on domestic
economic performance. The same survey asked whether it would have an effect on global
economic performance and 63% responded yes to that as well. There really is no way to tell who
was right or wrong about economic performance, either by measurement of predictive ability, or in
tangible data in hindsight. I can tell you, however, that if you ask a Republican whether sluggish
global growth is Obama’s fault, the answer will likely be yes and if you ask a Democrat whether a
Romney presidency would have caused a recession, the answer would again surely be yes.
There are two basic, overriding problems with attempting to measure a Presidential
administration’s effect on economic growth. The first is simply that the Executive Branch, through
the President has little leverage over the economy. For example, both Federal Reserve policy and
the price of oil exert much more influence over the course of growth and inflation than a President
could hope to have. Fiscal policy isn’t even remotely in the President’s control, particularly in an
environment like we have today, with one party controlling the White House and another
controlling the Congress. Secondly, most large changes in economic policy take many years some
perhaps a generation to be effective and be evaluated objectively. Consider the following: few
would argue that the Obamacare legislation was a hallmark of President Obama’s administration
and one that has the potential to affect US economic performance over the long run. Over the
course of the Obama administration, the economy’s trend growth has also fallen and productivity
has decreased in what has been described by many as a “sluggish” recovery. It would be foolish
(and statistically difficult) to conclude that Obamacare contributed to slower trend growth and
lower productivity, but that will not stop many from trying to make a link of causality where one
cannot be proven comprehensively. It is likely that decades of study will be necessary to
understand the true effects of a policy change as large as a universal healthcare mandate for the
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labour force and many other policies may drive economic prosperity or cause headwinds in the
intervening years.
As for the financial market effects, academic statistical research into whether Democratic or
Republican administrations are better for stock market returns is, at best, inconclusive. From the
1980s until the early 2000s, conventional wisdom in academia and reams of market commentary
was that better stock market returns were associated with Democratic administrations over
Republican ones. However, a Federal Reserve paper in 2004 that adjusted returns for volatility
found that the symbiotic link was tenuous. Some studies that measured from just before the Great
Depression showed better returns for Democrats, but other research shows little difference in
equity market returns by party going back to 1852. As usual in statistics, the time period matters
immensely, as does which data set one uses to come to a conclusion. The Leuthold Group and
Ned Davis Research studied Dow Jones Industrial Average performance separated by each of the
four the years of a Presidential cycle, concluding that the period after mid-term elections, or a
Presidential Administration’s third year, stock market returns rise most strongly. Still more
research by Credit Suisse in 2011 prior to the last election found that S&P 500 returns since 1926
were much stronger when the incumbent party was re-elected, versus when the Presidency
switched to a new party “ownership”. In most all of the studies we have seen and the large amount
of column inches expended on trying to prove one’s view, nearly every study is plagued by the fact
that there have been many notable “exceptions to the rule” they are attempting to offer as a proof.
So what is the conclusion? Sadly, there sometimes is no conclusive answer and this is one of
those instances. Evidence that “stock markets pick presidents” or that one party’s victory in a
single election has a causal and immediate effect on the economy are sparse and riddled with
potential for error and data-mining. There is a saying in the investment business that accompanies
any presentation of results, “Past performance is not necessarily an indicator of future
performance”. Regardless of who wins in November, that statement will always hold true. History
may repeat itself, but the reality is that sometimes it doesn’t and you shouldn’t construct a longterm investment portfolio based on an election cycle or which television personality is sitting in a
room without corners.
Sources
CFA Institute United States Presidential Pre=Election Poll – October 2012
CFA Institute, “Does the US Presidential Election Impact the Stock Market?” Lauren Foster 8/31/12
Electoral maths: Presidential elections and the S&P 500, John McDermott, FT Alphaville 12/14/11
Stan Collender's Capital Gains and Games Blog, Pete Davis, 11/4/08
Journal of Finance - Pedro Santa-Clara, Rossen I. Valkanov, 11/1/2003
The views expressed are the opinions of the writer and while believed reliable may differ from the views of Butterfield
Bank (Cayman) Ltd. The Bank accepts no liability for errors or actions taken on the basis of this information.
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