Which candidate will be best for the stock market?

October 24, 2012, Northern Illinois University
Which candidate will be best for the stock market?

With Election Day less than a month away, television is filled with talking heads spreading the conventional wisdom of what a Republican or Democratic president might mean for the economy.

However, a group of researchers says, when it comes to the relationship between presidential politics and the behavior of the , may not be so wise.

The researchers reviewed more than 40 years of data (1965-2008) in studying the relationship between security returns and four variables: the political affiliation of the president; the presence or absence of political gridlock; the presidential term cycle effect; and Federal Reserve monetary policy. While many have analyzed those factors separately, the authors of this study considered them simultaneously.

When all four of those factors were taken into account, the researchers concluded, many of the commonly held beliefs about how politics impact the market simply did not hold true.

Markets unmoved by a president's party affiliation

One of the most commonly repeated truisms called into question by the study is that the political affiliation of the president has an impact on the market. In reality, whether the president is a Republican or a Democrat is most often insignificant to the performance of the markets.

"While the party of the president garners much of the attention of the press, it appears that other factors have a much more prominent relationship with security returns," said Gerald Jensen, the Jones, Diedrich, Mennie professor of finance at the Northern Illinois University College of Business. He has spent years studying the topics covered in the study.

The misconception about the president's party affiliation appears to have grown out of research that looked at factors in isolation. For instance, numerous studies have shown that (especially for small stocks) are substantially higher during Democratic presidencies relative to Republican administrations. Similarly, bond returns during Republican administrations are twice as high relative to returns generated during Democratic administrations.

However, Jensen and his colleagues found that when you control for the other factors considered in this study, the difference in the performance of the markets across presidents from different parties is statistically insignificant.

Gridlock is not good

Many pundits, and researchers, maintain that political gridlock – which occurs when different parties control the White House and the legislature – is good for the

market. Under such conditions, they reason, there is less chance of significant fiscal policy actions, which tend to disrupt financial markets.

In reality, the authors report that political harmony is better for equities, especially smaller stock indexes where annualized returns were reportedly 22.38 percent higher during harmony as opposed to gridlock. Even when researchers adjusted for other factors, the benefits of political harmony remained clear, Jensen said.

Despite what the numbers say, the perception that gridlock is good has established itself.

"It has been repeated so often I think that it has sort of been accepted as fact," said Jensen, who speculates that people hang their argument on specific examples, like the Clinton presidency, when markets excelled despite political gridlock, and fail to consider other evidence.

While it is clear that, during the period studied, political harmony coincided with strong equity performance, Jensen and his fellow researchers stop short of saying that there is a dependency between the two. "We have identified a relationship, but we aren't saying that one causes the other," he cautioned.

Time will tell

While elections naturally bring up discussions of how politics influence the markets, Jensen and his colleagues found that political outcomes have little immediate impact. In fact, history has demonstrated that the most favorable return patterns are not manifested in the market for three years.

One theory is that the Federal Reserve loosens monetary policy in ways that reflect favorably upon incumbents in Congress and the White House to help encourage reelection. However, Jensen points out, even when the researchers adjusted for Fed policy changes, the economy seemed to consistently rally in the third year of a presidency.

It's all about the Fed

While much attention is focused on issues such as the president's and gridlock, investors might be better served by paying less attention to those factors and more to how the election might affect Federal Reserve policy, Jensen said.

"A tightening of Fed monetary policy generally precedes poor equity market performance and increased inflationary pressures. Ultimately, that factor seems to carry the greatest weight, and that is what investors should pay the most attention to," he said.

"In the end, policies are more important than politics," he continued. "While the Chairman of the Federal Reserve is appointed by the president, I don't think people pay much attention to what party he comes from. They pay attention to what he is doing. Perhaps they should look at politicians the same way. It's not their party affiliations that are important, but the policies that they put forth."

Explore further: Political variables do not improve the performance of trading rules

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2.6 / 5 (5) Oct 24, 2012
Better title would be: "Which lemming would be better for the rest of us lemmings to follow over the cliff."
3 / 5 (4) Oct 24, 2012
I expect a rise for a couple days if Romney wins or a fall for a couple days if Obama wins and then it will do whatever it was going to do as if there was no election at all.
1 / 5 (1) Oct 25, 2012
"A tightening of Fed monetary policy generally precedes poor equity market performance..."
Obviously as the US Government gives an interest return to savers more will save instead of desperately hedging against inflation by playing stocks. It follows that a booming stock market is not necessarily a sign of economic health, but a harbinger of banksters leveraging the petrodollar into yet another global depression. Basic economics

1 / 5 (2) Oct 25, 2012
i knew physorg was here for the stock market and the manipulation of it.
2.3 / 5 (6) Oct 25, 2012
This article is retarded. The Federal Reserve System chooses 3 candidates of its own for the President to appoint as Chairman. Therefor, any talk of "PARTY AFFILIATION" is absurd. Plus other small details might be the Fed is a privately owned bank, the Fed is a legal monopoly banking cartel in all but name, and a legal printing press. Lots of details left out...
1.8 / 5 (5) Oct 25, 2012
Hey natello, did you just travel in time from 2007 and miss the last 5 years?
3.7 / 5 (3) Oct 28, 2012
Over the last 5 years America has been living with an economy collapsed by failed Libertarian/Randite Ideology at the Fed, Failed everything by the Bush Administration, and a legacy of 30 years of borrow and spend Republicanism.

CapitalismFails seems to think that the American Economy should be booming after such spectacular Conservative treason.

Thinking people know better.

"We need to manufacture an (economic) crisis in order to assure that there are no alternatives to a smaller Government" - Libertarian Jeb Bush, Imprimus Magazine 1995

3 / 5 (4) Oct 28, 2012
Traditionally, Democrats have been better for the economy than Republicans.

Republicans destroy everything they touch. Democrats are left to try to repair the damage.

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